Here's Why Nan Pao Resins Chemical (TPE:4766) Can Manage Its Debt Responsibly

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.' 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. We can see that Nan Pao Resins Chemical Co., Ltd. (TPE:4766) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Nan Pao Resins Chemical

How Much Debt Does Nan Pao Resins Chemical Carry?

As you can see below, Nan Pao Resins Chemical had NT$3.18b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds NT$3.86b in cash, so it actually has NT$677.5m net cash.

A Look At Nan Pao Resins Chemical's Liabilities

Zooming in on the latest balance sheet data, we can see that Nan Pao Resins Chemical had liabilities of NT$4.67b due within 12 months and liabilities of NT$2.96b due beyond that. Offsetting these obligations, it had cash of NT$3.86b as well as receivables valued at NT$3.66b due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Nan Pao Resins Chemical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$18.8b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Nan Pao Resins Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Nan Pao Resins Chemical saw its EBIT drop by 2.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nan Pao Resins Chemical 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Nan Pao Resins Chemical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Nan Pao Resins Chemical's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Nan Pao Resins Chemical has NT$677.5m in net cash. So we don't have any problem with Nan Pao Resins Chemical's use of debt. 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. Be aware that Nan Pao Resins Chemical is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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