Is Chien Kuo Construction (TPE:5515) A Risky Investment?

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.' 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 Chien Kuo Construction Co., Ltd. (TPE:5515) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Chien Kuo Construction

What Is Chien Kuo Construction's Debt?

As you can see below, Chien Kuo Construction had NT$1.01b of debt at September 2020, down from NT$1.13b a year prior. But it also has NT$3.53b in cash to offset that, meaning it has NT$2.52b net cash.

A Look At Chien Kuo Construction's Liabilities

According to the last reported balance sheet, Chien Kuo Construction had liabilities of NT$3.39b due within 12 months, and liabilities of NT$1.20b due beyond 12 months. On the other hand, it had cash of NT$3.53b and NT$3.23b worth of receivables due within a year. So it can boast NT$2.16b more liquid assets than total liabilities.

This excess liquidity is a great indication that Chien Kuo Construction's balance sheet is just as strong as racists are weak. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Chien Kuo Construction boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Chien Kuo Construction grew its EBIT by 282% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Chien Kuo Construction 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Chien Kuo Construction 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. Happily for any shareholders, Chien Kuo Construction actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Chien Kuo Construction has NT$2.52b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 203% of that EBIT to free cash flow, bringing in NT$1.1b. The bottom line is that Chien Kuo Construction's use of debt is absolutely fine. 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. For example, we've discovered 1 warning sign for Chien Kuo Construction that you should be aware of before investing here.

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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