Health Check: How Prudently Does Chi Cheng Enterprise (GTSM:3095) Use Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that Chi Cheng Enterprise Co., Ltd. (GTSM:3095) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chi Cheng Enterprise

How Much Debt Does Chi Cheng Enterprise Carry?

As you can see below, Chi Cheng Enterprise had NT$115.6m of debt at September 2020, down from NT$573.1m a year prior. However, it also had NT$59.9m in cash, and so its net debt is NT$55.7m.

A Look At Chi Cheng Enterprise's Liabilities

The latest balance sheet data shows that Chi Cheng Enterprise had liabilities of NT$578.8m due within a year, and liabilities of NT$163.4m falling due after that. On the other hand, it had cash of NT$59.9m and NT$190.4m worth of receivables due within a year. So it has liabilities totalling NT$491.8m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the NT$308.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Chi Cheng Enterprise would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chi Cheng Enterprise 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.

In the last year Chi Cheng Enterprise had a loss before interest and tax, and actually shrunk its revenue by 19%, to NT$429m. We would much prefer see growth.

Caveat Emptor

While Chi Cheng Enterprise's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping NT$32m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of NT$9.4m over the last twelve months. That means it's on the risky side of things. 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 risks, for instance. Every company has them, and we've spotted 2 warning signs for Chi Cheng Enterprise 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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