Is Kanpai (GTSM:1269) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Kanpai Co., Ltd (GTSM:1269) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kanpai

How Much Debt Does Kanpai Carry?

As you can see below, Kanpai had NT$231.8m of debt at June 2020, down from NT$329.3m a year prior. But on the other hand it also has NT$518.7m in cash, leading to a NT$286.9m net cash position.

How Strong Is Kanpai's Balance Sheet?

The latest balance sheet data shows that Kanpai had liabilities of NT$630.2m due within a year, and liabilities of NT$608.0m falling due after that. On the other hand, it had cash of NT$518.7m and NT$127.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$592.2m.

Kanpai has a market capitalization of NT$1.40b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Kanpai also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Kanpai's EBIT fell a jaw-dropping 46% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kanpai'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Kanpai 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, Kanpai actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Kanpai's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$286.9m. And it impressed us with free cash flow of NT$369m, being 118% of its EBIT. So we are not troubled with Kanpai's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Kanpai that you should be aware of before investing here.

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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