San Fu Chemical (TPE:4755) Seems To Use Debt Rather Sparingly

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. Importantly, San Fu Chemical Co., Ltd. (TPE:4755) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 San Fu Chemical

How Much Debt Does San Fu Chemical Carry?

The image below, which you can click on for greater detail, shows that at September 2020 San Fu Chemical had debt of NT$727.0m, up from NT$467.0m in one year. On the flip side, it has NT$353.5m in cash leading to net debt of about NT$373.5m.

How Healthy Is San Fu Chemical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that San Fu Chemical had liabilities of NT$1.05b due within 12 months and liabilities of NT$267.5m due beyond that. Offsetting these obligations, it had cash of NT$353.5m as well as receivables valued at NT$1.03b due within 12 months. So it can boast NT$62.4m more liquid assets than total liabilities.

This state of affairs indicates that San Fu Chemical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$6.08b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

San Fu Chemical's net debt is only 0.56 times its EBITDA. And its EBIT covers its interest expense a whopping 103 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that San Fu Chemical has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if San Fu Chemical can strengthen its balance sheet over time. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, San Fu Chemical produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, San Fu Chemical's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think San Fu Chemical's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. To that end, you should be aware of the 2 warning signs we've spotted with San Fu Chemical .

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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