Does Kasen International Holdings (HKG:496) have a healthy balance sheet?

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Kasen International Holdings Limited (HKG:496) uses debt. But does this debt worry shareholders?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business 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.

Our analysis indicates that 496 is potentially undervalued!

How much debt does Kasen International Holdings have?

The image below, which you can click on for more details, shows that Kasen International Holdings had debt of 814.3 million yen at the end of June 2022, a reduction from 880.2 million yen on a year. However, since it has a cash reserve of 374.7 million Canadian yen, its net debt is less, at around 439.6 million domestic yen.

SEHK: 496 Debt to Equity History October 13, 2022

A look at the liabilities of Kasen International Holdings

Zooming in on the latest balance sheet data, we can see that Kasen International Holdings had liabilities of 1.59 billion Canadian yen due within 12 months and liabilities of 667.1 million domestic yen due beyond. On the other hand, it had cash of 374.7 million Canadian yen and 262.3 million national yen of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 1.62 billion Canadian yen.

This deficit casts a shadow over the 422.7 million yen enterprise, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, Kasen International Holdings would likely need a major recapitalization if it were to pay its creditors today.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Kasen International Holdings has net debt worth 1.9x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 3.1x operating expenses. ‘interests. While that doesn’t worry us too much, it does suggest that interest payments are a bit of a burden. Unfortunately, Kasen International Holdings has seen its EBIT drop by 9.8% over the last twelve months. If this earnings trend continues, its leverage will become heavy like the heart of a polar bear looking at its only cub. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of Kasen International Holdings that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Kasen International Holdings has had negative free cash flow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.

Our point of view

Reflecting on Kasen International Holdings’ attempt to stay above its total liabilities, we are certainly not enthusiastic. But at least its net debt to EBITDA isn’t that bad. Considering all the above factors, it seems that Kasen International Holdings is too leveraged. That kind of risk is acceptable to some, but it certainly doesn’t float our boat. 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. We have identified 2 warning signs with Kasen International Holdings, and understanding them should be part of your investment process.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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.

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