These 4 Measures Indicate That Chun Yuan Steel Industry (TPE:2010) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Chun Yuan Steel Industry Co., Ltd. (TPE:2010) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Chun Yuan Steel Industry

What Is Chun Yuan Steel Industry's Net Debt?

As you can see below, Chun Yuan Steel Industry had NT$4.63b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have NT$984.8m in cash offsetting this, leading to net debt of about NT$3.64b.

How Strong Is Chun Yuan Steel Industry's Balance Sheet?

The latest balance sheet data shows that Chun Yuan Steel Industry had liabilities of NT$6.70b due within a year, and liabilities of NT$976.5m falling due after that. On the other hand, it had cash of NT$984.8m and NT$7.11b worth of receivables due within a year. So it can boast NT$412.6m more liquid assets than total liabilities.

This surplus suggests that Chun Yuan Steel Industry has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

As it happens Chun Yuan Steel Industry has a fairly concerning net debt to EBITDA ratio of 5.8 but very strong interest coverage of 13.5. So either it has access to very cheap long term debt or that interest expense is going to grow! Notably, Chun Yuan Steel Industry's EBIT launched higher than Elon Musk, gaining a whopping 190% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Chun Yuan Steel Industry can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Chun Yuan Steel Industry burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Chun Yuan Steel Industry's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. But its interest cover was significantly redeeming. Considering this range of data points, we think Chun Yuan Steel Industry is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Chun Yuan Steel Industry (2 are a bit unpleasant) you should be aware of.

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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