Is Coaster International (TPE:2936) A Risky Investment?

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.' 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 note that Coaster International Co., Ltd. (TPE:2936) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Coaster International

What Is Coaster International's Debt?

As you can see below, Coaster International had NT$240.5m of debt at December 2020, down from NT$910.7m a year prior. But it also has NT$1.09b in cash to offset that, meaning it has NT$845.1m net cash.

How Strong Is Coaster International's Balance Sheet?

The latest balance sheet data shows that Coaster International had liabilities of NT$1.59b due within a year, and liabilities of NT$1.16b falling due after that. Offsetting this, it had NT$1.09b in cash and NT$666.6m in receivables that were due within 12 months. So it has liabilities totalling NT$996.1m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Coaster International has a market capitalization of NT$2.06b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Coaster International also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Coaster International's EBIT launched higher than Elon Musk, gaining a whopping 19,257% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is Coaster International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Coaster 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, Coaster International actually produced more free cash flow than EBIT over the last two 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

Although Coaster International's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$845.1m. And it impressed us with free cash flow of NT$2.1b, being 754% of its EBIT. So is Coaster International'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 3 warning signs for Coaster International (of which 1 is a bit concerning!) 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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