Here's Why Chien Shing Harbour ServiceLtd (TPE:8367) Has A Meaningful Debt Burden

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 note that Chien Shing Harbour Service Co.,Ltd. (TPE:8367) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Chien Shing Harbour ServiceLtd

What Is Chien Shing Harbour ServiceLtd's Net Debt?

As you can see below, at the end of September 2020, Chien Shing Harbour ServiceLtd had NT$3.15b of debt, up from NT$2.72b a year ago. Click the image for more detail. On the flip side, it has NT$445.0m in cash leading to net debt of about NT$2.70b.

A Look At Chien Shing Harbour ServiceLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Chien Shing Harbour ServiceLtd had liabilities of NT$1.39b due within 12 months and liabilities of NT$3.37b due beyond that. Offsetting these obligations, it had cash of NT$445.0m as well as receivables valued at NT$361.5m due within 12 months. So its liabilities total NT$3.95b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$2.23b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Chien Shing Harbour ServiceLtd would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Chien Shing Harbour ServiceLtd has a debt to EBITDA ratio of 4.6 and its EBIT covered its interest expense 4.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Also relevant is that Chien Shing Harbour ServiceLtd has grown its EBIT by a very respectable 28% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chien Shing Harbour ServiceLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Chien Shing Harbour ServiceLtd produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Chien Shing Harbour ServiceLtd's level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its EBIT growth rate was re-invigorating. When we consider all the factors discussed, it seems to us that Chien Shing Harbour ServiceLtd is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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, we've discovered 4 warning signs for Chien Shing Harbour ServiceLtd (1 makes us a bit uncomfortable!) 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. 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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