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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Kung Sing Engineering Corporation (TPE:5521) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Kung Sing Engineering

What Is Kung Sing Engineering's Net Debt?

The image below, which you can click on for greater detail, shows that Kung Sing Engineering had debt of NT$343.3m at the end of September 2020, a reduction from NT$2.84b over a year. However, its balance sheet shows it holds NT$1.91b in cash, so it actually has NT$1.56b net cash.

How Healthy 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. Offsetting these obligations, it had cash of NT$1.91b as well as receivables valued at NT$2.59b due within 12 months. So it actually has NT$1.84b more liquid assets than total liabilities.

This luscious liquidity implies that Kung Sing Engineering's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. 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. If maintained that growth will make the debt even more manageable in the years ahead. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. The bottom line is that Kung Sing Engineering's use of debt is absolutely fine. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Kung Sing Engineering's earnings per share history for free.

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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