Cosmos Machinery Enterprises (HKG:118) Has A Rock Solid Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Cosmos Machinery Enterprises Limited (HKG:118) does carry debt. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Cosmos Machinery Enterprises

What Is Cosmos Machinery Enterprises's Debt?

The image below, which you can click on for greater detail, shows that Cosmos Machinery Enterprises had debt of HK$277.4m at the end of June 2022, a reduction from HK$319.1m over a year. But on the other hand it also has HK$447.1m in cash, leading to a HK$169.8m net cash position.

How Strong Is Cosmos Machinery Enterprises' Balance Sheet?

The latest balance sheet data shows that Cosmos Machinery Enterprises had liabilities of HK$1.11b due within a year, and liabilities of HK$68.4m falling due after that. Offsetting these obligations, it had cash of HK$447.1m as well as receivables valued at HK$916.6m due within 12 months. So it can boast HK$188.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that Cosmos Machinery Enterprises' balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Cosmos Machinery Enterprises has more cash than debt is arguably a good indication that it can manage its debt safely.

Cosmos Machinery Enterprises's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cosmos Machinery Enterprises'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Cosmos Machinery Enterprises may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent two years, Cosmos Machinery Enterprises recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Cosmos Machinery Enterprises has net cash of HK$169.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$71m, being 78% of its EBIT. So is Cosmos Machinery Enterprises's debt a risk? It doesn't seem so to us. 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 2 warning signs for Cosmos Machinery Enterprises that you should be aware of before investing here.

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. 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.