Here's Why King Chou Marine Technology (GTSM:4417) Can Manage Its Debt Responsibly

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, King Chou Marine Technology Co., Ltd. (GTSM:4417) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for King Chou Marine Technology

What Is King Chou Marine Technology's Debt?

As you can see below, King Chou Marine Technology had NT$716.5m of debt at December 2020, down from NT$1.03b a year prior. However, its balance sheet shows it holds NT$727.8m in cash, so it actually has NT$11.2m net cash.

How Strong Is King Chou Marine Technology's Balance Sheet?

We can see from the most recent balance sheet that King Chou Marine Technology had liabilities of NT$910.7m falling due within a year, and liabilities of NT$457.8m due beyond that. Offsetting this, it had NT$727.8m in cash and NT$740.4m in receivables that were due within 12 months. So it actually has NT$99.7m more liquid assets than total liabilities.

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

But the other side of the story is that King Chou Marine Technology saw its EBIT decline by 2.3% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is King Chou Marine Technology's earnings that will influence how the balance sheet holds up in the future. 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. King Chou Marine Technology 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. Looking at the most recent three years, King Chou Marine Technology recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that King Chou Marine Technology has net cash of NT$11.2m, as well as more liquid assets than liabilities. So we don't have any problem with King Chou Marine Technology's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for King Chou Marine Technology you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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