Is Shenzhen Kedali Industry (SZSE:002850) A Risky Investment?

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 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 Shenzhen Kedali Industry Co., Ltd. (SZSE:002850) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shenzhen Kedali Industry

What Is Shenzhen Kedali Industry's Debt?

The chart below, which you can click on for greater detail, shows that Shenzhen Kedali Industry had CN¥2.76b in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥3.25b in cash, so it actually has CN¥495.6m net cash.

A Look At Shenzhen Kedali Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Kedali Industry had liabilities of CN¥5.34b due within 12 months and liabilities of CN¥1.84b due beyond that. Offsetting these obligations, it had cash of CN¥3.25b as well as receivables valued at CN¥5.26b due within 12 months. So it can boast CN¥1.33b more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen Kedali Industry could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenzhen Kedali Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shenzhen Kedali Industry has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Kedali Industry'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen Kedali Industry has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Shenzhen Kedali Industry burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Kedali Industry has net cash of CN¥495.6m, as well as more liquid assets than liabilities. And we liked the look of last year's 49% year-on-year EBIT growth. So we are not troubled with Shenzhen Kedali Industry's debt use. 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. Case in point: We've spotted 2 warning signs for Shenzhen Kedali Industry you should be aware of, and 1 of them is potentially serious.

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.