Would Kinko Optical (TPE:6209) Be Better Off With Less Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Kinko Optical Co., Ltd. (TPE:6209) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kinko Optical

How Much Debt Does Kinko Optical Carry?

As you can see below, at the end of September 2020, Kinko Optical had NT$728.9m of debt, up from NT$494.1m a year ago. Click the image for more detail. However, it also had NT$698.3m in cash, and so its net debt is NT$30.6m.

A Look At Kinko Optical's Liabilities

According to the last reported balance sheet, Kinko Optical had liabilities of NT$1.16b due within 12 months, and liabilities of NT$310.9m due beyond 12 months. Offsetting these obligations, it had cash of NT$698.3m as well as receivables valued at NT$874.8m due within 12 months. So it actually has NT$97.2m more liquid assets than total liabilities.

Having regard to Kinko Optical's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$5.87b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Kinko Optical has a very light debt load indeed. There's no doubt that we learn most about debt from the balance sheet. But it is Kinko Optical'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.

In the last year Kinko Optical had a loss before interest and tax, and actually shrunk its revenue by 13%, to NT$2.9b. That's not what we would hope to see.

Caveat Emptor

While Kinko Optical's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost NT$184m at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Kinko Optical .

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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