Chunghwa Chemical Synthesis & Biotech (TWSE:1762) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Chunghwa Chemical Synthesis & Biotech Co., Ltd. (TWSE:1762) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Chunghwa Chemical Synthesis & Biotech

How Much Debt Does Chunghwa Chemical Synthesis & Biotech Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Chunghwa Chemical Synthesis & Biotech had debt of NT$1.00b, up from NT$820.0m in one year. On the flip side, it has NT$213.1m in cash leading to net debt of about NT$786.9m.

How Healthy Is Chunghwa Chemical Synthesis & Biotech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chunghwa Chemical Synthesis & Biotech had liabilities of NT$663.9m due within 12 months and liabilities of NT$983.2m due beyond that. On the other hand, it had cash of NT$213.1m and NT$205.9m worth of receivables due within a year. So its liabilities total NT$1.23b more than the combination of its cash and short-term receivables.

Chunghwa Chemical Synthesis & Biotech has a market capitalization of NT$3.17b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chunghwa Chemical Synthesis & Biotech has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 5.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Chunghwa Chemical Synthesis & Biotech's EBIT fell a jaw-dropping 80% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Chunghwa Chemical Synthesis & Biotech will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Chunghwa Chemical Synthesis & Biotech recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Chunghwa Chemical Synthesis & Biotech's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its interest cover is not so bad. We're quite clear that we consider Chunghwa Chemical Synthesis & Biotech to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example - Chunghwa Chemical Synthesis & Biotech has 3 warning signs we think you should be aware of.

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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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.