Is Ho Tung Chemical (TPE:1714) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Ho Tung Chemical Corp. (TPE:1714) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ho Tung Chemical

How Much Debt Does Ho Tung Chemical Carry?

You can click the graphic below for the historical numbers, but it shows that Ho Tung Chemical had NT$3.49b of debt in September 2020, down from NT$5.77b, one year before. But on the other hand it also has NT$7.20b in cash, leading to a NT$3.70b net cash position.

How Healthy Is Ho Tung Chemical's Balance Sheet?

According to the last reported balance sheet, Ho Tung Chemical had liabilities of NT$4.60b due within 12 months, and liabilities of NT$3.22b due beyond 12 months. Offsetting this, it had NT$7.20b in cash and NT$3.50b in receivables that were due within 12 months. So it can boast NT$2.87b more liquid assets than total liabilities.

This surplus suggests that Ho Tung Chemical is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Ho Tung Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Ho Tung Chemical grew its EBIT by 251% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ho Tung Chemical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Ho Tung Chemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Ho Tung Chemical actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Ho Tung Chemical has net cash of NT$3.70b, as well as more liquid assets than liabilities. The cherry on top was that in converted 126% of that EBIT to free cash flow, bringing in NT$5.3b. The bottom line is that we do not find Ho Tung Chemical's debt levels at all concerning. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Ho Tung Chemical's earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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