Is Shenzhen KSTAR Science and Technology (SZSE:002518) Using Too Much Debt?

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. Importantly, Shenzhen KSTAR Science and Technology Co., Ltd. (SZSE:002518) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for Shenzhen KSTAR Science and Technology

What Is Shenzhen KSTAR Science and Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen KSTAR Science and Technology had CN¥48.0m of debt in March 2024, down from CN¥64.4m, one year before. However, its balance sheet shows it holds CN¥1.60b in cash, so it actually has CN¥1.55b net cash.

A Look At Shenzhen KSTAR Science and Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen KSTAR Science and Technology had liabilities of CN¥1.98b due within 12 months and liabilities of CN¥285.8m due beyond that. On the other hand, it had cash of CN¥1.60b and CN¥1.53b worth of receivables due within a year. So it actually has CN¥864.5m more liquid assets than total liabilities.

This surplus suggests that Shenzhen KSTAR Science and Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen KSTAR Science and Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shenzhen KSTAR Science and Technology's saving grace is its low debt levels, because its EBIT has tanked 25% 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 ultimately the future profitability of the business will decide if Shenzhen KSTAR Science and Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shenzhen KSTAR Science and 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 most recent three years, Shenzhen KSTAR Science and Technology recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen KSTAR Science and Technology has CN¥1.55b in net cash and a decent-looking balance sheet. So we don't have any problem with Shenzhen KSTAR Science and Technology's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Shenzhen KSTAR Science and Technology (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com