Is Kuo Yang ConstructionLtd (TPE:2505) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Kuo Yang Construction Co.,Ltd (TPE:2505) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Kuo Yang ConstructionLtd

What Is Kuo Yang ConstructionLtd's Debt?

As you can see below, Kuo Yang ConstructionLtd had NT$5.83b of debt at September 2020, down from NT$8.10b a year prior. But it also has NT$6.16b in cash to offset that, meaning it has NT$330.4m net cash.

How Strong Is Kuo Yang ConstructionLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kuo Yang ConstructionLtd had liabilities of NT$8.37b due within 12 months and liabilities of NT$72.0m due beyond that. Offsetting these obligations, it had cash of NT$6.16b as well as receivables valued at NT$570.1m due within 12 months. So it has liabilities totalling NT$1.71b more than its cash and near-term receivables, combined.

Since publicly traded Kuo Yang ConstructionLtd shares are worth a total of NT$14.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Kuo Yang ConstructionLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Kuo Yang ConstructionLtd grew its EBIT by 3,815% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kuo Yang ConstructionLtd will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kuo Yang ConstructionLtd 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 last two years, Kuo Yang ConstructionLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Kuo Yang ConstructionLtd does have more liabilities than liquid assets, it also has net cash of NT$330.4m. The cherry on top was that in converted 160% of that EBIT to free cash flow, bringing in NT$8.4b. So we don't think Kuo Yang ConstructionLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Kuo Yang ConstructionLtd , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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