Khgears International (TWSE:4571) Could Easily Take On More Debt

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Khgears International Limited (TWSE:4571) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Khgears International

What Is Khgears International's Net Debt?

The image below, which you can click on for greater detail, shows that Khgears International had debt of NT$79.2m at the end of June 2024, a reduction from NT$91.1m over a year. But it also has NT$1.13b in cash to offset that, meaning it has NT$1.05b net cash.

How Healthy Is Khgears International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Khgears International had liabilities of NT$1.07b due within 12 months and liabilities of NT$49.6m due beyond that. Offsetting this, it had NT$1.13b in cash and NT$850.6m in receivables that were due within 12 months. So it actually has NT$867.1m more liquid assets than total liabilities.

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

On top of that, Khgears International grew its EBIT by 90% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Khgears International's earnings that will influence how the balance sheet holds up in the future. 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. Khgears International 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. During the last three years, Khgears International generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd 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 Khgears International has net cash of NT$1.05b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$564m, being 92% of its EBIT. So is Khgears International'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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Khgears International (of which 1 makes us a bit uncomfortable!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.