Qualipoly Chemical (TPE:4722) Could Easily Take On More Debt

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. As with many other companies Qualipoly Chemical Corporation (TPE:4722) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Qualipoly Chemical

What Is Qualipoly Chemical's Debt?

You can click the graphic below for the historical numbers, but it shows that Qualipoly Chemical had NT$161.4m of debt in September 2020, down from NT$360.4m, one year before. But it also has NT$236.5m in cash to offset that, meaning it has NT$75.1m net cash.

How Strong Is Qualipoly Chemical's Balance Sheet?

The latest balance sheet data shows that Qualipoly Chemical had liabilities of NT$599.3m due within a year, and liabilities of NT$97.4m falling due after that. On the other hand, it had cash of NT$236.5m and NT$856.1m worth of receivables due within a year. So it actually has NT$395.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Qualipoly Chemical could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Qualipoly Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Qualipoly Chemical grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Qualipoly Chemical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Qualipoly 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. Over the last three years, Qualipoly Chemical actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Qualipoly Chemical has net cash of NT$75.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$451m, being 124% of its EBIT. So is Qualipoly Chemical's debt a risk? It doesn't seem so to us. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Qualipoly Chemical (at least 1 which is concerning) , 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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