Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that KSEC Intelligent Technology Co., Ltd. (SZSE:301311) does have debt on its balance sheet. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is KSEC Intelligent Technology's Debt?
As you can see below, at the end of September 2023, KSEC Intelligent Technology had CN¥400.0m of debt, up from CN¥310.3m a year ago. Click the image for more detail. But it also has CN¥618.4m in cash to offset that, meaning it has CN¥218.4m net cash.
How Healthy Is KSEC Intelligent Technology's Balance Sheet?
According to the last reported balance sheet, KSEC Intelligent Technology had liabilities of CN¥2.13b due within 12 months, and liabilities of CN¥478.8m due beyond 12 months. On the other hand, it had cash of CN¥618.4m and CN¥1.73b worth of receivables due within a year. So its liabilities total CN¥258.9m more than the combination of its cash and short-term receivables.
Since publicly traded KSEC Intelligent Technology shares are worth a total of CN¥4.88b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, KSEC Intelligent Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact KSEC Intelligent Technology's saving grace is its low debt levels, because its EBIT has tanked 54% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since KSEC Intelligent Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. KSEC Intelligent 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. Over the last three years, KSEC Intelligent Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that KSEC Intelligent Technology has CN¥218.4m in net cash. So while KSEC Intelligent Technology does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. 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 KSEC Intelligent Technology (of which 1 is a bit unpleasant!) you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.