Is Evergreen International Storage & Transport (TPE:2607) Using Too Much 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.' 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 can see that Evergreen International Storage & Transport Corporation (TPE:2607) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Evergreen International Storage & Transport

How Much Debt Does Evergreen International Storage & Transport Carry?

The image below, which you can click on for greater detail, shows that Evergreen International Storage & Transport had debt of NT$5.07b at the end of September 2020, a reduction from NT$5.44b over a year. However, it does have NT$4.78b in cash offsetting this, leading to net debt of about NT$286.5m.

How Strong Is Evergreen International Storage & Transport's Balance Sheet?

According to the last reported balance sheet, Evergreen International Storage & Transport had liabilities of NT$3.55b due within 12 months, and liabilities of NT$7.63b due beyond 12 months. Offsetting these obligations, it had cash of NT$4.78b as well as receivables valued at NT$982.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$5.42b.

Evergreen International Storage & Transport has a market capitalization of NT$16.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Evergreen International Storage & Transport has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.099 and EBIT of 16.2 times the interest expense. So relative to past earnings, the debt load seems trivial. But the bad news is that Evergreen International Storage & Transport has seen its EBIT plunge 19% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Evergreen International Storage & Transport 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Evergreen International Storage & Transport actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Evergreen International Storage & Transport's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. It's also worth noting that Evergreen International Storage & Transport is in the Infrastructure industry, which is often considered to be quite defensive. Looking at all the aforementioned factors together, it strikes us that Evergreen International Storage & Transport can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Evergreen International Storage & Transport has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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