Here's Why Kingstate Electronics (GTSM:3206) Can Manage Its Debt Responsibly

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.' 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 Kingstate Electronics Corp. (GTSM:3206) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Kingstate Electronics

How Much Debt Does Kingstate Electronics Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Kingstate Electronics had debt of NT$111.7m, up from none in one year. But on the other hand it also has NT$290.1m in cash, leading to a NT$178.4m net cash position.

How Strong Is Kingstate Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kingstate Electronics had liabilities of NT$1.39b due within 12 months and liabilities of NT$91.8m due beyond that. On the other hand, it had cash of NT$290.1m and NT$1.27b worth of receivables due within a year. So it can boast NT$75.9m more liquid assets than total liabilities.

This surplus suggests that Kingstate Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Kingstate Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Kingstate Electronics grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kingstate Electronics'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Kingstate Electronics 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. Looking at the most recent three years, Kingstate Electronics recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Kingstate Electronics has NT$178.4m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 13% in the last twelve months. So we don't think Kingstate Electronics's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Kingstate Electronics is showing 2 warning signs in our investment analysis , you should know about...

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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