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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies MeiG Smart Technology Co., Ltd (SZSE:002881) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for MeiG Smart Technology
How Much Debt Does MeiG Smart Technology Carry?
The image below, which you can click on for greater detail, shows that MeiG Smart Technology had debt of CN¥73.0m at the end of September 2023, a reduction from CN¥373.3m over a year. But it also has CN¥255.6m in cash to offset that, meaning it has CN¥182.6m net cash.
How Healthy Is MeiG Smart Technology's Balance Sheet?
We can see from the most recent balance sheet that MeiG Smart Technology had liabilities of CN¥637.1m falling due within a year, and liabilities of CN¥48.5m due beyond that. Offsetting these obligations, it had cash of CN¥255.6m as well as receivables valued at CN¥684.6m due within 12 months. So it actually has CN¥254.5m more liquid assets than total liabilities.
This short term liquidity is a sign that MeiG Smart Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that MeiG Smart Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact MeiG Smart Technology's saving grace is its low debt levels, because its EBIT has tanked 58% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MeiG Smart Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. MeiG Smart Technology 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, MeiG Smart Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that MeiG Smart Technology has net cash of CN¥182.6m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about MeiG Smart Technology's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with MeiG Smart Technology (at least 1 which can't be ignored) , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.