These 4 Measures Indicate That Nan Pao Resins Chemical (TWSE:4766) Is Using Debt Safely

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.' 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. As with many other companies Nan Pao Resins Chemical Co., Ltd. (TWSE:4766) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Nan Pao Resins Chemical

What Is Nan Pao Resins Chemical's Net Debt?

As you can see below, at the end of September 2024, Nan Pao Resins Chemical had NT$5.13b of debt, up from NT$2.99b a year ago. Click the image for more detail. However, it does have NT$6.80b in cash offsetting this, leading to net cash of NT$1.67b.

How Healthy Is Nan Pao Resins Chemical's Balance Sheet?

We can see from the most recent balance sheet that Nan Pao Resins Chemical had liabilities of NT$8.03b falling due within a year, and liabilities of NT$3.61b due beyond that. On the other hand, it had cash of NT$6.80b and NT$6.00b worth of receivables due within a year. So it actually has NT$1.16b more liquid assets than total liabilities.

This surplus suggests that Nan Pao Resins Chemical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Nan Pao Resins Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Nan Pao Resins Chemical has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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 company can only pay off debt with cold hard cash, not accounting profits. Nan Pao Resins 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. During the last three years, Nan Pao Resins Chemical produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nan Pao Resins Chemical has net cash of NT$1.67b, as well as more liquid assets than liabilities. And we liked the look of last year's 36% year-on-year EBIT growth. So we don't think Nan Pao Resins Chemical's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Nan Pao Resins Chemical's dividend history, without delay!

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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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.