Chen Full International (GTSM:8383) Could Easily Take On More Debt

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. We note that Chen Full International Co., Ltd. (GTSM:8383) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Chen Full International

How Much Debt Does Chen Full International Carry?

The image below, which you can click on for greater detail, shows that Chen Full International had debt of NT$100.0m at the end of September 2020, a reduction from NT$280.0m over a year. However, its balance sheet shows it holds NT$683.0m in cash, so it actually has NT$583.0m net cash.

How Healthy Is Chen Full International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chen Full International had liabilities of NT$1.20b due within 12 months and liabilities of NT$173.5m due beyond that. Offsetting these obligations, it had cash of NT$683.0m as well as receivables valued at NT$1.02b due within 12 months. So it can boast NT$324.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Chen Full International could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Chen Full International has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Chen Full International grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chen Full International 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Chen Full International 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, Chen Full International produced sturdy free cash flow equating to 62% 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 it is always sensible to investigate a company's debt, in this case Chen Full International has NT$583.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 31% over the last year. So we don't think Chen Full International's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Chen Full International (at least 1 which is significant) , and understanding them should be part of your investment process.

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. 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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