Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies King Wan Corporation Limited (SGX:554) uses debt. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest review for King Wan
What is King Wan’s debt?
The image below, which you can click on for more details, shows that King Wan had a debt of S$11.2 million at the end of March 2022, a reduction from S$33.4 million on a year. However, he has S$18.0 million to offset this, resulting in a net cash of S$6.76 million.
How healthy is King Wan’s balance sheet?
Zooming in on the latest balance sheet data, we can see that King Wan had liabilities of S$52.4 million due within 12 months and liabilities of S$3.78 million due beyond. In return, he had S$18.0 million in cash and S$31.1 million in debt due within 12 months. Thus, its liabilities total S$7.16 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that bad since King Wan has a market capitalization of S$27.9 million, so it could likely bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution. While he has some liabilities to note, King Wan also has more cash than debt, so we’re pretty confident he can safely manage his debt.
It was also good to see that despite losing money on the EBIT line last year, King Wan turned things around in the last 12 months, delivering an EBIT of S$225,000. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since King Wan will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, while the taxman may love accounting profits, lenders only accept cash. King Wan may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its capacity. . to manage debt. Fortunately for all shareholders, King Wan has actually produced more free cash flow than EBIT over the past year. There’s nothing better than incoming money to stay in the good books of your lenders.
Although King Wan has more liabilities than liquid assets, he also has a net cash of S$6.76 million. And it impressed us with free cash flow of S$3.3 million, or 1,488% of its EBIT. So we don’t think King Wan’s use of debt is risky. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 2 warning signs we spotted with King Wan (including 1 that didn’t suit us too much).
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.