Stock Analysis

Does Standard Chem & Pharm (TPE:1720) Have A Healthy Balance Sheet?

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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. We note that Standard Chem & Pharm CO., LTD. (TPE:1720) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 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 Standard Chem & Pharm

What Is Standard Chem & Pharm's Net Debt?

The image below, which you can click on for greater detail, shows that Standard Chem & Pharm had debt of NT$675.5m at the end of September 2020, a reduction from NT$1.18b over a year. However, it does have NT$1.34b in cash offsetting this, leading to net cash of NT$661.1m.

TSEC:1720 Debt to Equity History March 1st 2021

How Strong Is Standard Chem & Pharm's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Standard Chem & Pharm had liabilities of NT$1.62b due within 12 months and liabilities of NT$493.0m due beyond that. On the other hand, it had cash of NT$1.34b and NT$960.6m worth of receivables due within a year. So it can boast NT$188.9m more liquid assets than total liabilities.

This surplus suggests that Standard Chem & Pharm has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Standard Chem & Pharm boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Standard Chem & Pharm grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. 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 Standard Chem & Pharm 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Standard Chem & Pharm 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 most recent three years, Standard Chem & Pharm recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 Standard Chem & Pharm has net cash of NT$661.1m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 47% over the last year. So we don't think Standard Chem & Pharm's use of debt is risky. 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 Standard Chem & Pharm is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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