Does Kung Sing Engineering (TPE:5521) Have A Healthy Balance Sheet?

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.' 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 note that Kung Sing Engineering Corporation (TPE:5521) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kung Sing Engineering

How Much Debt Does Kung Sing Engineering Carry?

You can click the graphic below for the historical numbers, but it shows that Kung Sing Engineering had NT$343.3m of debt in September 2020, down from NT$2.84b, one year before. However, its balance sheet shows it holds NT$1.91b in cash, so it actually has NT$1.56b net cash.

How Strong Is Kung Sing Engineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kung Sing Engineering had liabilities of NT$2.42b due within 12 months and liabilities of NT$236.6m due beyond that. On the other hand, it had cash of NT$1.91b and NT$2.59b worth of receivables due within a year. So it can boast NT$1.84b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kung Sing Engineering's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Kung Sing Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Kung Sing Engineering grew its EBIT by 12,023% last year, which is an impressive improvement. 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 Kung Sing Engineering 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Kung Sing Engineering 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, Kung Sing Engineering actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kung Sing Engineering has net cash of NT$1.56b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$3.1b, being 274% of its EBIT. When it comes to Kung Sing Engineering's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. Case in point: We've spotted 1 warning sign for Kung Sing Engineering 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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