Is Ju-Kao Engineering (GTSM:1594) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ju-Kao Engineering Co., Ltd. (GTSM:1594) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ju-Kao Engineering

What Is Ju-Kao Engineering's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Ju-Kao Engineering had debt of NT$164.6m, up from NT$136.8m in one year. However, its balance sheet shows it holds NT$189.9m in cash, so it actually has NT$25.2m net cash.

How Strong Is Ju-Kao Engineering's Balance Sheet?

According to the last reported balance sheet, Ju-Kao Engineering had liabilities of NT$290.3m due within 12 months, and liabilities of NT$64.4m due beyond 12 months. On the other hand, it had cash of NT$189.9m and NT$269.7m worth of receivables due within a year. So it can boast NT$104.9m more liquid assets than total liabilities.

This excess liquidity suggests that Ju-Kao Engineering is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Ju-Kao Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Ju-Kao Engineering grew its EBIT by 14% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ju-Kao Engineering's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ju-Kao Engineering 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 last three years, Ju-Kao Engineering actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Ju-Kao Engineering has net cash of NT$25.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$61m, being 131% of its EBIT. So we don't think Ju-Kao Engineering's use of debt is risky. 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 2 warning signs for Ju-Kao Engineering you should be aware of.

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.

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This article by Simply Wall St is general in nature. 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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