Does Chung Hung Steel (TPE:2014) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Chung Hung Steel Corporation (TPE:2014) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Chung Hung Steel

How Much Debt Does Chung Hung Steel Carry?

As you can see below, Chung Hung Steel had NT$10.1b of debt at December 2020, down from NT$14.2b a year prior. However, it also had NT$1.35b in cash, and so its net debt is NT$8.76b.

How Healthy Is Chung Hung Steel's Balance Sheet?

According to the last reported balance sheet, Chung Hung Steel had liabilities of NT$5.17b due within 12 months, and liabilities of NT$6.70b due beyond 12 months. On the other hand, it had cash of NT$1.35b and NT$993.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$9.52b.

Of course, Chung Hung Steel has a market capitalization of NT$61.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chung Hung Steel's net debt is 4.2 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 17.1 is very high, suggesting that the interest expense on the debt is currently quite low. We also note that Chung Hung Steel improved its EBIT from a last year's loss to a positive NT$915m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Chung Hung Steel's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Chung Hung Steel actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Chung Hung Steel's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its net debt to EBITDA has the opposite effect. When we consider the range of factors above, it looks like Chung Hung Steel is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Chung Hung Steel , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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