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 note that Chi Cheng Enterprise Co., Ltd. (GTSM:3095) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

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$575.8m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have NT$59.9m in cash offsetting this, leading to net debt of about NT$515.8m.

How Healthy Is Chi Cheng Enterprise's Balance Sheet?

According to the last reported balance sheet, Chi Cheng Enterprise had liabilities of NT$578.8m due within 12 months, and liabilities of NT$163.4m due beyond 12 months. 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.

This deficit casts a shadow over the NT$290.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Chi Cheng Enterprise would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chi Cheng Enterprise'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.

Over 12 months, Chi Cheng Enterprise made a loss at the EBIT level, and saw its revenue drop to NT$429m, which is a fall of 19%. That's not what we would hope to see.

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. Indeed, it lost a very considerable NT$41m at the EBIT level. 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 burned through NT$9.4m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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 instance, we've identified 1 warning sign for Chi Cheng Enterprise that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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