Kossan Rubber Industries Bhd (KLSE:KOSSAN) Has A Rock Solid Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Kossan Rubber Industries Bhd (KLSE:KOSSAN) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, 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.

View our latest analysis for Kossan Rubber Industries Bhd

What Is Kossan Rubber Industries Bhd's Debt?

The image below, which you can click on for greater detail, shows that Kossan Rubber Industries Bhd had debt of RM304.8m at the end of September 2021, a reduction from RM511.7m over a year. However, its balance sheet shows it holds RM2.71b in cash, so it actually has RM2.40b net cash.

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

Zooming in on the latest balance sheet data, we can see that Kossan Rubber Industries Bhd had liabilities of RM1.11b due within 12 months and liabilities of RM220.8m due beyond that. Offsetting these obligations, it had cash of RM2.71b as well as receivables valued at RM927.2m due within 12 months. So it actually has RM2.30b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kossan Rubber Industries Bhd's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Kossan Rubber Industries Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Kossan Rubber Industries Bhd grew its EBIT by 458% over twelve months. That boost will make it even easier to pay down debt going forward. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 72% 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 RM2.40b in net cash and a decent-looking balance sheet. And we liked the look of last year's 458% year-on-year EBIT growth. The bottom line is that Kossan Rubber Industries Bhd's use of debt is absolutely fine. 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. Case in point: We've spotted 3 warning signs for Kossan Rubber Industries Bhd you should be aware of, and 1 of them makes us a bit uncomfortable.

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.

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.

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