Kung Long Batteries IndustrialLtd (TPE:1537) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Kung Long Batteries Industrial Co.,Ltd (TPE:1537) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Kung Long Batteries IndustrialLtd

What Is Kung Long Batteries IndustrialLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Kung Long Batteries IndustrialLtd had debt of NT$230.0m at the end of September 2020, a reduction from NT$638.0m over a year. But on the other hand it also has NT$1.78b in cash, leading to a NT$1.55b net cash position.

A Look At Kung Long Batteries IndustrialLtd's Liabilities

According to the last reported balance sheet, Kung Long Batteries IndustrialLtd had liabilities of NT$1.11b due within 12 months, and liabilities of NT$439.2m due beyond 12 months. 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. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kung Long Batteries IndustrialLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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 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 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. When analysing debt levels, the balance sheet is the obvious place to start. 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 1 warning sign with Kung Long Batteries IndustrialLtd , 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.

If you’re looking to trade Kung Long Batteries IndustrialLtd, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.