Cosmos Machinery Enterprises (HKG:118) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Cosmos Machinery Enterprises Limited (HKG:118) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Cosmos Machinery Enterprises

How Much Debt Does Cosmos Machinery Enterprises Carry?

As you can see below, Cosmos Machinery Enterprises had HK$322.3m of debt at December 2020, down from HK$363.0m a year prior. But on the other hand it also has HK$499.7m in cash, leading to a HK$177.3m net cash position.

A Look At Cosmos Machinery Enterprises' Liabilities

We can see from the most recent balance sheet that Cosmos Machinery Enterprises had liabilities of HK$1.23b falling due within a year, and liabilities of HK$107.1m due beyond that. Offsetting these obligations, it had cash of HK$499.7m as well as receivables valued at HK$1.04b due within 12 months. So it actually has HK$202.4m more liquid assets than total liabilities.

This surplus strongly suggests that Cosmos Machinery Enterprises has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Cosmos Machinery Enterprises boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Cosmos Machinery Enterprises grew its EBIT by 58% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cosmos Machinery Enterprises 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.

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. During the last three years, Cosmos Machinery Enterprises burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Cosmos Machinery Enterprises has HK$177.3m in net cash and a decent-looking balance sheet. And we liked the look of last year's 58% year-on-year EBIT growth. So we are not troubled with Cosmos Machinery Enterprises's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Cosmos Machinery Enterprises .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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