Is Kawan Food Berhad (KLSE:KAWAN) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Kawan Food Berhad (KLSE:KAWAN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Kawan Food Berhad

How Much Debt Does Kawan Food Berhad Carry?

As you can see below, Kawan Food Berhad had RM15.2m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have RM79.8m in cash offsetting this, leading to net cash of RM64.6m.

How Strong Is Kawan Food Berhad's Balance Sheet?

According to the last reported balance sheet, Kawan Food Berhad had liabilities of RM54.2m due within 12 months, and liabilities of RM15.0m due beyond 12 months. On the other hand, it had cash of RM79.8m and RM49.1m worth of receivables due within a year. So it actually has RM59.7m more liquid assets than total liabilities.

This surplus suggests that Kawan Food Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Kawan Food Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Kawan Food Berhad has boosted its EBIT by 80%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kawan Food Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kawan Food Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Kawan Food Berhad recorded free cash flow worth 74% 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 it is always sensible to investigate a company's debt, in this case Kawan Food Berhad has RM64.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 80% over the last year. So we don't think Kawan Food Berhad's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Kawan Food Berhad, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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