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.' 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. We can see that United Nova Technology Co.,Ltd. (SHSE:688469) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is United Nova TechnologyLtd's Net Debt?
As you can see below, United Nova TechnologyLtd had CN¥9.98b of debt at September 2023, down from CN¥13.3b a year prior. However, it also had CN¥5.29b in cash, and so its net debt is CN¥4.69b.
How Strong Is United Nova TechnologyLtd's Balance Sheet?
We can see from the most recent balance sheet that United Nova TechnologyLtd had liabilities of CN¥8.93b falling due within a year, and liabilities of CN¥9.09b due beyond that. Offsetting these obligations, it had cash of CN¥5.29b as well as receivables valued at CN¥364.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥12.4b.
This deficit isn't so bad because United Nova TechnologyLtd is worth CN¥37.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if United Nova TechnologyLtd 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.
Over 12 months, United Nova TechnologyLtd reported revenue of CN¥5.3b, which is a gain of 33%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
Despite the top line growth, United Nova TechnologyLtd still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥1.8b. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥10b in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for United Nova TechnologyLtd (of which 1 makes us a bit uncomfortable!) you should know about.
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.