Chung Hwa Chemical Industrial Works (TPE:1727) Is Carrying A Fair Bit Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Chung Hwa Chemical Industrial Works, Ltd. (TPE:1727) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Chung Hwa Chemical Industrial Works

What Is Chung Hwa Chemical Industrial Works's Debt?

As you can see below, Chung Hwa Chemical Industrial Works had NT$754.9m of debt at September 2020, down from NT$848.3m a year prior. However, it also had NT$62.0m in cash, and so its net debt is NT$692.9m.

How Healthy Is Chung Hwa Chemical Industrial Works' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chung Hwa Chemical Industrial Works had liabilities of NT$537.9m due within 12 months and liabilities of NT$498.1m due beyond that. On the other hand, it had cash of NT$62.0m and NT$532.9m worth of receivables due within a year. So its liabilities total NT$441.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Chung Hwa Chemical Industrial Works has a market capitalization of NT$1.19b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chung Hwa Chemical Industrial Works will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Chung Hwa Chemical Industrial Works made a loss at the EBIT level, and saw its revenue drop to NT$2.0b, which is a fall of 18%. That's not what we would hope to see.

Caveat Emptor

While Chung Hwa Chemical Industrial Works's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at NT$27m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of NT$146m into a profit. In the meantime, we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Chung Hwa Chemical Industrial Works (of which 1 is a bit unpleasant!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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