Is King Core Electronics (TPE:6155) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, King Core Electronics Inc. (TPE:6155) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for King Core Electronics

What Is King Core Electronics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 King Core Electronics had NT$830.0m of debt, an increase on NT$600.0m, over one year. However, it does have NT$913.9m in cash offsetting this, leading to net cash of NT$83.9m.

How Strong Is King Core Electronics' Balance Sheet?

The latest balance sheet data shows that King Core Electronics had liabilities of NT$984.5m due within a year, and liabilities of NT$37.9m falling due after that. Offsetting these obligations, it had cash of NT$913.9m as well as receivables valued at NT$193.7m due within 12 months. So it can boast NT$85.2m more liquid assets than total liabilities.

This surplus suggests that King Core Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that King Core Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that King Core Electronics has seen its EBIT plunge 10% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is King Core 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 King Core 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. Happily for any shareholders, King Core Electronics actually produced more free cash flow than EBIT over the last three 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

While we empathize with investors who find debt concerning, you should keep in mind that King Core Electronics has net cash of NT$83.9m, as well as more liquid assets than liabilities. The cherry on top was that in converted 179% of that EBIT to free cash flow, bringing in NT$43m. So we don't think King Core Electronics'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 5 warning signs with King Core Electronics (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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