We Think Chaintech Technology (TPE:2425) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Chaintech Technology Corporation (TPE:2425) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Chaintech Technology

What Is Chaintech Technology's Net Debt?

As you can see below, at the end of September 2020, Chaintech Technology had NT$406.1m of debt, up from NT$171.5m a year ago. Click the image for more detail. However, it does have NT$519.1m in cash offsetting this, leading to net cash of NT$113.0m.

How Healthy Is Chaintech Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chaintech Technology had liabilities of NT$945.1m due within 12 months and liabilities of NT$14.8m due beyond that. Offsetting this, it had NT$519.1m in cash and NT$1.23b in receivables that were due within 12 months. So it can boast NT$789.4m more liquid assets than total liabilities.

This excess liquidity suggests that Chaintech Technology is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Chaintech Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Chaintech Technology has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chaintech Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Chaintech Technology 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. In the last three years, Chaintech Technology's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Chaintech Technology has net cash of NT$113.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 44% over the last year. So we don't think Chaintech Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Chaintech Technology (including 1 which makes us a bit uncomfortable) .

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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