Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Above all, King’s Town Construction Co., Ltd. (FTE: 2524) bears the debt. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
What is King’s Town Construction net debt?
As you can see below, King’s Town Construction had NT $ 15.9 billion in debt as of September 2020, up from NT $ 20.3 billion the year before. However, he also had NT $ 325.8 million in cash, so his net debt is NT $ 15.5 billion.
How strong is King’s Town Construction’s balance sheet?
According to the latest published balance sheet, King’s Town Construction had liabilities of NT $ 10.5 billion due within 12 months and liabilities of NT $ 7.26 billion due beyond 12 months. In compensation for these obligations, it had cash of NT $ 325.8 million as well as receivables valued at NT $ 142.6 million due within 12 months. Thus, its liabilities exceed the sum of its cash and debts (short term) by NT $ 17.3 billion.
When you consider that this deficit exceeds the company’s NT $ 12.9 billion market cap, you may well be inclined to take a close look at the balance sheet. Hypothetically, an extremely large dilution would be required if the company was forced to repay its debts by raising capital at the current share price.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
King’s Town Construction’s net debt to EBITDA ratio is 6.9, which suggests rather high debt levels, but its 8.3 times interest coverage suggests debt servicing is easy. Overall, we would say it seems likely that the company is carrying some pretty heavy debt. It is important to note that King’s Town Construction has increased its EBIT by 44% over the past twelve months, and this growth will make it easier to process its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of King’s Town Construction that will influence the balance sheet in the future. So if you want to know more about his earnings, it might be worth checking out this graph of his long-term profit trend.
Finally, a business can only pay off its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years King’s Town Construction has generated free cash flow of a very strong 93% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Our point of view
We were not impressed with King’s Town Construction’s level of total liabilities, and its net debt to EBITDA made us cautious. But like a ballerina finishing on a perfect spin, she has no trouble converting her EBIT into free cash flow. Looking at all of this data, we feel a little cautious about King’s Town Construction’s debt levels. While debt has its advantage in terms of potential higher returns, we believe shareholders should definitely consider how leverage levels might make the stock riskier. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To do this, you need to know the 1 warning sign we spotted with King’s Town Construction .
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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