Kwong Fong Industries (TWSE:1416) Is Making Moderate Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Kwong Fong Industries Corporation (TWSE:1416) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kwong Fong Industries

What Is Kwong Fong Industries's Debt?

As you can see below, at the end of March 2024, Kwong Fong Industries had NT$773.5m of debt, up from NT$560.4m a year ago. Click the image for more detail. However, it also had NT$275.5m in cash, and so its net debt is NT$498.1m.

How Strong Is Kwong Fong Industries' Balance Sheet?

We can see from the most recent balance sheet that Kwong Fong Industries had liabilities of NT$313.1m falling due within a year, and liabilities of NT$742.0m due beyond that. Offsetting these obligations, it had cash of NT$275.5m as well as receivables valued at NT$69.8m due within 12 months. So its liabilities total NT$709.8m more than the combination of its cash and short-term receivables.

Kwong Fong Industries has a market capitalization of NT$2.04b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kwong Fong 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.

Over 12 months, Kwong Fong Industries reported revenue of NT$296m, which is a gain of 8.2%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Kwong Fong Industries had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost NT$4.0m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of NT$100m and a profit of NT$125m. So one might argue that there's still a chance it can get things on the right track. 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. For example - Kwong Fong Industries has 2 warning signs we think 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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