Here's Why Kai Chieh International Investment (GTSM:2721) Can Afford Some 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.' 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 can see that Kai Chieh International Investment Ltd. (GTSM:2721) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kai Chieh International Investment

What Is Kai Chieh International Investment's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Kai Chieh International Investment had debt of NT$199.2m, up from NT$183.7m in one year. On the flip side, it has NT$56.7m in cash leading to net debt of about NT$142.5m.

How Healthy Is Kai Chieh International Investment's Balance Sheet?

The latest balance sheet data shows that Kai Chieh International Investment had liabilities of NT$500.0m due within a year, and liabilities of NT$146.0m falling due after that. On the other hand, it had cash of NT$56.7m and NT$19.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$569.5m.

This is a mountain of leverage relative to its market capitalization of NT$713.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kai Chieh International Investment 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.

In the last year Kai Chieh International Investment had a loss before interest and tax, and actually shrunk its revenue by 14%, to NT$272m. That's not what we would hope to see.

Caveat Emptor

While Kai Chieh International Investment's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping NT$119m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through NT$34m of cash over the last year. So suffice it to say we do consider the stock to be 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 3 warning signs for Kai Chieh International Investment (1 is potentially serious) you should be aware of.

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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