Is Kaulin Mfg (TPE:1531) Using Debt Sensibly?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Kaulin Mfg. Co., Ltd. (TPE:1531) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kaulin Mfg

What Is Kaulin Mfg's Debt?

The chart below, which you can click on for greater detail, shows that Kaulin Mfg had NT$100.0m in debt in September 2020; about the same as the year before. But it also has NT$1.21b in cash to offset that, meaning it has NT$1.11b net cash.

How Healthy Is Kaulin Mfg's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kaulin Mfg had liabilities of NT$444.0m due within 12 months and liabilities of NT$271.1m due beyond that. Offsetting these obligations, it had cash of NT$1.21b as well as receivables valued at NT$736.3m due within 12 months. So it can boast NT$1.23b more liquid assets than total liabilities.

This surplus liquidity suggests that Kaulin Mfg's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Kaulin Mfg boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kaulin Mfg 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.

In the last year Kaulin Mfg had a loss before interest and tax, and actually shrunk its revenue by 30%, to NT$1.6b. That makes us nervous, to say the least.

So How Risky Is Kaulin Mfg?

While Kaulin Mfg lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow NT$209m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. There's no doubt the next few years will be crucial to how the business matures. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Kaulin Mfg (1 doesn't sit too well with us) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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