L&K Engineering (TWSE:6139) 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 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 note that L&K Engineering Co., Ltd. (TWSE:6139) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for L&K Engineering

How Much Debt Does L&K Engineering Carry?

You can click the graphic below for the historical numbers, but it shows that L&K Engineering had NT$1.71b of debt in June 2024, down from NT$5.59b, one year before. However, its balance sheet shows it holds NT$21.8b in cash, so it actually has NT$20.1b net cash.

How Strong Is L&K Engineering's Balance Sheet?

We can see from the most recent balance sheet that L&K Engineering had liabilities of NT$36.5b falling due within a year, and liabilities of NT$1.46b due beyond that. Offsetting this, it had NT$21.8b in cash and NT$21.3b in receivables that were due within 12 months. So it actually has NT$5.18b more liquid assets than total liabilities.

This surplus suggests that L&K Engineering has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, L&K Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that L&K Engineering grew its EBIT by 232% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since L&K Engineering 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. L&K 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. Over the last three years, L&K Engineering actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that L&K Engineering has net cash of NT$20.1b, as well as more liquid assets than liabilities. The cherry on top was that in converted 261% of that EBIT to free cash flow, bringing in NT$9.6b. So we don't think L&K Engineering's use of debt is risky. 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. For instance, we've identified 2 warning signs for L&K Engineering that you should be aware of.

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.

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

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.