These 4 Measures Indicate That World Known MFG (Cayman) (TPE:4581) Is Using Debt Reasonably Well

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. As with many other companies World Known MFG (Cayman) Limited (TPE:4581) makes use of debt. 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. 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.

See our latest analysis for World Known MFG (Cayman)

What Is World Known MFG (Cayman)'s Debt?

As you can see below, at the end of September 2020, World Known MFG (Cayman) had NT$58.7m of debt, up from NT$43.8m a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$232.5m in cash, so it actually has NT$173.8m net cash.

How Strong Is World Known MFG (Cayman)'s Balance Sheet?

We can see from the most recent balance sheet that World Known MFG (Cayman) had liabilities of NT$337.0m falling due within a year, and liabilities of NT$46.9m due beyond that. Offsetting this, it had NT$232.5m in cash and NT$173.7m in receivables that were due within 12 months. So it actually has NT$22.3m more liquid assets than total liabilities.

This state of affairs indicates that World Known MFG (Cayman)'s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$1.39b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that World Known MFG (Cayman) has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact World Known MFG (Cayman)'s saving grace is its low debt levels, because its EBIT has tanked 47% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since World Known MFG (Cayman) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. World Known MFG (Cayman) 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. Happily for any shareholders, World Known MFG (Cayman) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case World Known MFG (Cayman) has NT$173.8m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$187m, being 131% of its EBIT. So we are not troubled with World Known MFG (Cayman)'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. Be aware that World Known MFG (Cayman) is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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