Is China Petrochemical Development (TWSE:1314) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, China Petrochemical Development Corporation (TWSE:1314) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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 China Petrochemical Development

What Is China Petrochemical Development's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 China Petrochemical Development had NT$51.7b of debt, an increase on NT$48.8b, over one year. However, it does have NT$11.3b in cash offsetting this, leading to net debt of about NT$40.3b.

How Healthy Is China Petrochemical Development's Balance Sheet?

We can see from the most recent balance sheet that China Petrochemical Development had liabilities of NT$30.4b falling due within a year, and liabilities of NT$36.6b due beyond that. Offsetting this, it had NT$11.3b in cash and NT$3.96b in receivables that were due within 12 months. So it has liabilities totalling NT$51.7b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of NT$41.6b, we think shareholders really should watch China Petrochemical Development's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Petrochemical Development'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.

Over 12 months, China Petrochemical Development reported revenue of NT$29b, which is a gain of 29%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, China Petrochemical Development still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost NT$2.4b at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through NT$4.5b in negative free cash flow over the last year. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with China Petrochemical Development (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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