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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that iFLYTEK CO.,LTD (SZSE:002230) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is iFLYTEKLTD's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 iFLYTEKLTD had debt of CN¥4.78b, up from CN¥1.95b in one year. However, because it has a cash reserve of CN¥3.40b, its net debt is less, at about CN¥1.39b.
How Strong Is iFLYTEKLTD's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that iFLYTEKLTD had liabilities of CN¥13.0b due within 12 months and liabilities of CN¥5.45b due beyond that. Offsetting these obligations, it had cash of CN¥3.40b as well as receivables valued at CN¥14.3b due within 12 months. So its liabilities total CN¥804.0m more than the combination of its cash and short-term receivables.
Having regard to iFLYTEKLTD's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥105.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, iFLYTEKLTD has a very light debt load indeed. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine iFLYTEKLTD's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, iFLYTEKLTD made a loss at the EBIT level, and saw its revenue drop to CN¥19b, which is a fall of 6.6%. That's not what we would hope to see.
Caveat Emptor
Importantly, iFLYTEKLTD had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥773m at the EBIT level. 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. However, it doesn't help that it burned through CN¥2.0b of cash over the last year. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with iFLYTEKLTD , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.