Hsin Kao GasLtd (TPE:9931) Has A Pretty Healthy Balance Sheet

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 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. We can see that Hsin Kao Gas Co.,Ltd. (TPE:9931) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

View our latest analysis for Hsin Kao GasLtd

What Is Hsin Kao GasLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Hsin Kao GasLtd had debt of NT$113.8m, up from NT$51.1m in one year. But on the other hand it also has NT$853.1m in cash, leading to a NT$739.3m net cash position.

A Look At Hsin Kao GasLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Hsin Kao GasLtd had liabilities of NT$1.60b due within 12 months and liabilities of NT$967.2m due beyond that. Offsetting this, it had NT$853.1m in cash and NT$168.6m in receivables that were due within 12 months. So it has liabilities totalling NT$1.54b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hsin Kao GasLtd has a market capitalization of NT$4.59b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Hsin Kao GasLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Hsin Kao GasLtd's EBIT dived 16%, over the last year. 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 you can't view debt in total isolation; since Hsin Kao GasLtd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hsin Kao GasLtd 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, Hsin Kao GasLtd 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 Hsin Kao GasLtd does have more liabilities than liquid assets, it also has net cash of NT$739.3m. And it impressed us with free cash flow of NT$109m, being 102% of its EBIT. So we are not troubled with Hsin Kao GasLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Hsin Kao GasLtd , 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.

When trading Hsin Kao GasLtd or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.