Is Cheng Mei Materials Technology (TPE:4960) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Cheng Mei Materials Technology Corporation (TPE:4960) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Cheng Mei Materials Technology

What Is Cheng Mei Materials Technology's Net Debt?

As you can see below, Cheng Mei Materials Technology had NT$3.10b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of NT$502.6m, its net debt is less, at about NT$2.59b.

How Strong Is Cheng Mei Materials Technology's Balance Sheet?

The latest balance sheet data shows that Cheng Mei Materials Technology had liabilities of NT$4.60b due within a year, and liabilities of NT$354.2m falling due after that. Offsetting this, it had NT$502.6m in cash and NT$2.78b in receivables that were due within 12 months. So its liabilities total NT$1.67b more than the combination of its cash and short-term receivables.

Given Cheng Mei Materials Technology has a market capitalization of NT$9.75b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But it is Cheng Mei Materials Technology'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, Cheng Mei Materials Technology made a loss at the EBIT level, and saw its revenue drop to NT$9.5b, which is a fall of 36%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Cheng Mei Materials Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost NT$270m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through NT$522m of cash over the last year. So in short it's a really risky stock. 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. Be aware that Cheng Mei Materials Technology is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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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