Standard Chem & Pharm (TPE:1720) Seems To Use Debt Rather Sparingly

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.' 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. As with many other companies Standard Chem & Pharm CO., LTD. (TPE:1720) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Standard Chem & Pharm

What Is Standard Chem & Pharm's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Standard Chem & Pharm had NT$675.5m of debt in September 2020, down from NT$1.18b, one year before. However, its balance sheet shows it holds NT$1.34b in cash, so it actually has NT$661.1m net cash.

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

The latest balance sheet data shows that Standard Chem & Pharm had liabilities of NT$1.62b due within a year, and liabilities of NT$493.0m falling due after that. Offsetting these obligations, it had cash of NT$1.34b as well as receivables valued at NT$960.6m due within 12 months. 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. Simply put, the fact that Standard Chem & Pharm has more cash than debt is arguably a good indication that it can manage its debt safely.

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. There's no doubt that we learn most about debt from the balance sheet. But it is Standard Chem & Pharm's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 we liked the look of last year's 47% year-on-year EBIT growth. So is Standard Chem & Pharm's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Standard Chem & Pharm that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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