Here's Why La Kaffa International (GTSM:2732) 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.' 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 La Kaffa International Co., Ltd. (GTSM:2732) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

Check out our latest analysis for La Kaffa International

How Much Debt Does La Kaffa International Carry?

As you can see below, at the end of September 2020, La Kaffa International had NT$997.2m of debt, up from NT$463.2m a year ago. Click the image for more detail. However, it does have NT$1.34b in cash offsetting this, leading to net cash of NT$342.8m.

How Strong Is La Kaffa International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that La Kaffa International had liabilities of NT$2.01b due within 12 months and liabilities of NT$519.1m due beyond that. Offsetting this, it had NT$1.34b in cash and NT$352.0m in receivables that were due within 12 months. So its liabilities total NT$836.0m more than the combination of its cash and short-term receivables.

Since publicly traded La Kaffa International shares are worth a total of NT$5.23b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, La Kaffa International also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for La Kaffa International if management cannot prevent a repeat of the 56% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if La Kaffa International can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. La Kaffa 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. Happily for any shareholders, La Kaffa International actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While La Kaffa International does have more liabilities than liquid assets, it also has net cash of NT$342.8m. And it impressed us with free cash flow of NT$622m, being 129% of its EBIT. So we don't have any problem with La Kaffa International's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for La Kaffa International that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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