We Think Hsin Kao GasLtd (TPE:9931) Can Stay On Top Of Its Debt

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.' 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 note that Hsin Kao Gas Co.,Ltd. (TPE:9931) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hsin Kao GasLtd

How Much Debt Does Hsin Kao GasLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Hsin Kao GasLtd had debt of NT$102.2m, up from NT$35.5m in one year. But it also has NT$774.0m in cash to offset that, meaning it has NT$671.8m net cash.

How Healthy Is Hsin Kao GasLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hsin Kao GasLtd had liabilities of NT$1.55b due within 12 months and liabilities of NT$952.2m due beyond that. Offsetting this, it had NT$774.0m in cash and NT$149.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.58b.

Hsin Kao GasLtd has a market capitalization of NT$4.73b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Hsin Kao GasLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Hsin Kao GasLtd has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Hsin Kao GasLtd generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While Hsin Kao GasLtd does have more liabilities than liquid assets, it also has net cash of NT$671.8m. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in NT$81m. So we are not troubled with Hsin Kao GasLtd's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hsin Kao GasLtd's earnings per share history for free.

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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