Is Sinkang Industries (TPE:2032) A Risky Investment?

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.' 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. We note that Sinkang Industries Co., Ltd. (TPE:2032) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sinkang Industries

What Is Sinkang Industries's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Sinkang Industries had debt of NT$117.9m, up from NT$58.3m in one year. But it also has NT$185.7m in cash to offset that, meaning it has NT$67.8m net cash.

A Look At Sinkang Industries' Liabilities

The latest balance sheet data shows that Sinkang Industries had liabilities of NT$225.7m due within a year, and liabilities of NT$192.4m falling due after that. On the other hand, it had cash of NT$185.7m and NT$715.8m worth of receivables due within a year. So it can boast NT$483.4m more liquid assets than total liabilities.

This excess liquidity suggests that Sinkang Industries is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sinkang Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Sinkang Industries grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sinkang Industries 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sinkang Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Sinkang Industries saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Sinkang Industries has NT$67.8m in net cash and a decent-looking balance sheet. And we liked the look of last year's 42% year-on-year EBIT growth. So is Sinkang Industries's debt a risk? It doesn't seem so to us. 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. Be aware that Sinkang Industries is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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