Is Kung Long Batteries IndustrialLtd (TPE:1537) 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. We note that Kung Long Batteries Industrial Co.,Ltd (TPE:1537) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kung Long Batteries IndustrialLtd

What Is Kung Long Batteries IndustrialLtd's Debt?

As you can see below, Kung Long Batteries IndustrialLtd had NT$230.0m of debt at September 2020, down from NT$638.0m a year prior. But it also has NT$1.78b in cash to offset that, meaning it has NT$1.55b net cash.

A Look At Kung Long Batteries IndustrialLtd's Liabilities

The latest balance sheet data shows that Kung Long Batteries IndustrialLtd had liabilities of NT$1.11b due within a year, and liabilities of NT$439.2m falling due after that. Offsetting this, it had NT$1.78b in cash and NT$956.0m in receivables that were due within 12 months. So it actually has NT$1.19b more liquid assets than total liabilities.

This short term liquidity is a sign that Kung Long Batteries IndustrialLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Kung Long Batteries IndustrialLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

While Kung Long Batteries IndustrialLtd doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Kung Long Batteries IndustrialLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Kung Long Batteries IndustrialLtd 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, Kung Long Batteries IndustrialLtd recorded free cash flow worth a fulsome 98% 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 we empathize with investors who find debt concerning, you should keep in mind that Kung Long Batteries IndustrialLtd has net cash of NT$1.55b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$1.3b, being 98% of its EBIT. So is Kung Long Batteries IndustrialLtd's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Kung Long Batteries IndustrialLtd , and understanding them should be part of your investment process.

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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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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