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

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Kossan Rubber Industries Bhd (KLSE:KOSSAN) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kossan Rubber Industries Bhd

What Is Kossan Rubber Industries Bhd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Kossan Rubber Industries Bhd had RM208.3m of debt in March 2022, down from RM479.6m, one year before. But on the other hand it also has RM2.55b in cash, leading to a RM2.35b net cash position.

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 RM584.5m due within 12 months and liabilities of RM181.5m due beyond that. Offsetting this, it had RM2.55b in cash and RM489.2m in receivables that were due within 12 months. So it actually has RM2.28b 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. 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!

On the other hand, Kossan Rubber Industries Bhd saw its EBIT drop by 8.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Kossan Rubber Industries Bhd 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 Kossan Rubber Industries Bhd 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. 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 we empathize with investors who find debt concerning, you should keep in mind that Kossan Rubber Industries Bhd has net cash of RM2.35b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM2.5b, being 75% of its EBIT. So is Kossan Rubber Industries Bhd'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. Case in point: We've spotted 2 warning signs for Kossan Rubber Industries Bhd you should be aware of, and 1 of them doesn't sit too well with us.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.