We Think Chung Hung Steel (TPE:2014) Has A Fair Chunk Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Chung Hung Steel Corporation (TPE:2014) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Chung Hung Steel

What Is Chung Hung Steel's Debt?

The image below, which you can click on for greater detail, shows that Chung Hung Steel had debt of NT$12.0b at the end of September 2020, a reduction from NT$13.6b over a year. However, it also had NT$1.48b in cash, and so its net debt is NT$10.6b.

How Strong Is Chung Hung Steel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chung Hung Steel had liabilities of NT$6.91b due within 12 months and liabilities of NT$7.03b due beyond that. Offsetting these obligations, it had cash of NT$1.48b as well as receivables valued at NT$1.18b due within 12 months. So its liabilities total NT$11.3b more than the combination of its cash and short-term receivables.

Chung Hung Steel has a market capitalization of NT$22.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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 ultimately the future profitability of the business will decide if Chung Hung Steel 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.

In the last year Chung Hung Steel had a loss before interest and tax, and actually shrunk its revenue by 23%, to NT$34b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Chung Hung Steel's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$619m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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$649m into a profit. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Chung Hung Steel has 2 warning signs we think 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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