Stock Analysis

Is Kossan Rubber Industries Bhd (KLSE:KOSSAN) A Risky Investment?

Source: Shutterstock

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.' 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. Importantly, Kossan Rubber Industries Bhd (KLSE:KOSSAN) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kossan Rubber Industries Bhd

How Much Debt Does Kossan Rubber Industries Bhd Carry?

The image below, which you can click on for greater detail, shows that Kossan Rubber Industries Bhd had debt of RM70.9m at the end of December 2022, a reduction from RM237.4m over a year. But it also has RM2.07b in cash to offset that, meaning it has RM2.00b net cash.

KLSE:KOSSAN Debt to Equity History March 17th 2023

How Healthy Is Kossan Rubber Industries Bhd's Balance Sheet?

We can see from the most recent balance sheet that Kossan Rubber Industries Bhd had liabilities of RM263.3m falling due within a year, and liabilities of RM147.5m due beyond that. On the other hand, it had cash of RM2.07b and RM491.6m worth of receivables due within a year. So it can boast RM2.15b more liquid assets than total liabilities.

This luscious liquidity implies that Kossan Rubber Industries Bhd's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Kossan Rubber Industries Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Kossan Rubber Industries Bhd if management cannot prevent a repeat of the 96% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Kossan Rubber Industries Bhd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kossan Rubber Industries Bhd 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, Kossan Rubber Industries Bhd produced sturdy free cash flow equating to 75% 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Kossan Rubber Industries Bhd has RM2.00b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in -RM17m. So is Kossan Rubber Industries Bhd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kossan Rubber Industries Bhd you should know about.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Kossan Rubber Industries Bhd is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis