King Polytechnic Engineering (GTSM:6122) Has A Rock Solid Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that King Polytechnic Engineering Co., Ltd. (GTSM:6122) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for King Polytechnic Engineering

What Is King Polytechnic Engineering's Debt?

As you can see below, at the end of September 2020, King Polytechnic Engineering had NT$444.3m of debt, up from NT$354.8m a year ago. Click the image for more detail. However, because it has a cash reserve of NT$296.7m, its net debt is less, at about NT$147.6m.

A Look At King Polytechnic Engineering's Liabilities

The latest balance sheet data shows that King Polytechnic Engineering had liabilities of NT$1.21b due within a year, and liabilities of NT$41.3m falling due after that. Offsetting these obligations, it had cash of NT$296.7m as well as receivables valued at NT$1.21b due within 12 months. So it can boast NT$256.3m more liquid assets than total liabilities.

This luscious liquidity implies that King Polytechnic Engineering's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

King Polytechnic Engineering's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. One way King Polytechnic Engineering could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 18%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is King Polytechnic 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. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, King Polytechnic Engineering actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, King Polytechnic Engineering's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We think King Polytechnic Engineering is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for King Polytechnic Engineering that 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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