Huikwang (GTSM:6508) Could Easily Take On More Debt

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. Importantly, Huikwang Corporation (GTSM:6508) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huikwang

How Much Debt Does Huikwang Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Huikwang had debt of NT$458.7m, up from NT$419.7m in one year. But it also has NT$817.2m in cash to offset that, meaning it has NT$358.5m net cash.

How Strong Is Huikwang's Balance Sheet?

According to the last reported balance sheet, Huikwang had liabilities of NT$713.0m due within 12 months, and liabilities of NT$127.8m due beyond 12 months. Offsetting this, it had NT$817.2m in cash and NT$517.7m in receivables that were due within 12 months. So it actually has NT$494.1m more liquid assets than total liabilities.

This excess liquidity suggests that Huikwang is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Huikwang boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Huikwang has increased its EBIT by 2.9% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Huikwang'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. Huikwang 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 most recent three years, Huikwang recorded free cash flow worth 80% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Huikwang has net cash of NT$358.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$261m, being 80% of its EBIT. So is Huikwang's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Huikwang you should know about.

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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