Is Kuen Ling Machinery Refrigerating (GTSM:4527) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Kuen Ling Machinery Refrigerating Co., Ltd. (GTSM:4527) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Kuen Ling Machinery Refrigerating

What Is Kuen Ling Machinery Refrigerating's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Kuen Ling Machinery Refrigerating had debt of NT$235.2m, up from NT$214.9m in one year. However, its balance sheet shows it holds NT$523.1m in cash, so it actually has NT$287.9m net cash.

How Healthy Is Kuen Ling Machinery Refrigerating's Balance Sheet?

The latest balance sheet data shows that Kuen Ling Machinery Refrigerating had liabilities of NT$914.7m due within a year, and liabilities of NT$274.5m falling due after that. Offsetting this, it had NT$523.1m in cash and NT$815.4m in receivables that were due within 12 months. So it actually has 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. Succinctly put, Kuen Ling Machinery Refrigerating boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Kuen Ling Machinery Refrigerating grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. 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 company can only pay off debt with cold hard cash, not accounting profits. 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 positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Kuen Ling Machinery Refrigerating has NT$287.9m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$243m, being 88% of its EBIT. So is Kuen Ling Machinery Refrigerating'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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Kuen Ling Machinery Refrigerating (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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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