Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Tsaker Chemical Group Limited (HKG:1986) is in debt. But should shareholders worry about its use of debt?
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Tsaker Chemical Group
What is Tsaker Chemical Group’s debt?
The image below, which you can click for more details, shows that Tsaker Chemical Group had a debt of 315.7 million Canadian yen at the end of December 2021, a reduction from 349.7 million yen Canadians over one year. However, he has 208.7 million Canadian yen in cash to offset this, resulting in a net debt of approximately 107.0 million Canadian yen.
How strong is Tsaker Chemical Group’s balance sheet?
According to the latest published balance sheet, Tsaker Chemical Group had liabilities of 637.1 million Canadian yen due within 12 months and liabilities of 40.0 million domestic yen due beyond 12 months. In return, he had 208.7 million yen in cash and 325.2 million yen in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 143.1 million Canadian yen.
Given that Tsaker Chemical Group has a market capitalization of 1.39 billion Canadian yen, it’s hard to believe that these liabilities pose a threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Tsaker Chemical Group’s net debt is only 0.24 times its EBITDA. And its EBIT easily covers its interest charges, which is 15.7 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are pleased to report that Tsaker Chemical Group increased its EBIT by 50%, reducing the specter of future debt repayments. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of Tsaker Chemical Group that will influence the balance sheet in the future. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Tsaker Chemical Group has produced strong free cash flow equivalent to 55% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
The good news is that Tsaker Chemical Group’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Zooming out, Tsaker Chemical Group appears to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Tsaker Chemical Group you should know.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.