Is Kuen Ling Machinery Refrigerating (GTSM:4527) A Risky Investment?
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Kuen Ling Machinery Refrigerating Co., Ltd. (GTSM:4527) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Kuen Ling Machinery Refrigerating
How Much Debt Does Kuen Ling Machinery Refrigerating Carry?
The chart below, which you can click on for greater detail, shows that Kuen Ling Machinery Refrigerating had NT$213.2m in debt in September 2020; about the same as the year before. However, its balance sheet shows it holds NT$523.1m in cash, so it actually has NT$309.9m net cash.
How Strong Is Kuen Ling Machinery Refrigerating's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kuen Ling Machinery Refrigerating had liabilities of NT$914.7m due within 12 months and liabilities of NT$274.5m due beyond that. On the other hand, it had cash of NT$523.1m and NT$815.4m worth of receivables due within a year. So it can boast NT$149.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Kuen Ling Machinery Refrigerating could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Kuen Ling Machinery Refrigerating has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Kuen Ling Machinery Refrigerating has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. 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 Kuen Ling Machinery Refrigerating will need earnings to service that debt. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Kuen Ling Machinery Refrigerating 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. Over the last three years, Kuen Ling Machinery Refrigerating recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Kuen Ling Machinery Refrigerating has net cash of NT$309.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$243m, being 88% of its EBIT. So we don't think Kuen Ling Machinery Refrigerating'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 3 warning signs for Kuen Ling Machinery Refrigerating you should be aware of, and 1 of them makes us a bit uncomfortable.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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About TPEX:4527
Kuen Ling Machinery Refrigerating
Kuen Ling Machinery Refrigerating Co., Ltd.
Solid track record with excellent balance sheet.