We Think Chunghwa Telecom (TWSE:2412) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Chunghwa Telecom Co., Ltd. (TWSE:2412) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Chunghwa Telecom

What Is Chunghwa Telecom's Debt?

The chart below, which you can click on for greater detail, shows that Chunghwa Telecom had NT$32.5b in debt in June 2024; about the same as the year before. But on the other hand it also has NT$67.9b in cash, leading to a NT$35.5b net cash position.

A Look At Chunghwa Telecom's Liabilities

The latest balance sheet data shows that Chunghwa Telecom had liabilities of NT$96.2b due within a year, and liabilities of NT$62.9b falling due after that. On the other hand, it had cash of NT$67.9b and NT$32.0b worth of receivables due within a year. So it has liabilities totalling NT$59.2b more than its cash and near-term receivables, combined.

Of course, Chunghwa Telecom has a titanic market capitalization of NT$961.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Chunghwa Telecom also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Chunghwa Telecom saw its EBIT drop by 2.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Chunghwa Telecom 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. While Chunghwa Telecom has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Chunghwa Telecom recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

We could understand if investors are concerned about Chunghwa Telecom's liabilities, but we can be reassured by the fact it has has net cash of NT$35.5b. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in NT$46b. So we don't think Chunghwa Telecom'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. For example, we've discovered 1 warning sign for Chunghwa Telecom that you should be aware of before investing here.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.