Kingfa Sci. & Tech (SHSE:600143) Use Of Debt Could Be Considered Risky

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Kingfa Sci. & Tech. Co., Ltd. (SHSE:600143) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kingfa Sci. & Tech

How Much Debt Does Kingfa Sci. & Tech Carry?

As you can see below, Kingfa Sci. & Tech had CN¥28.3b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥3.86b in cash, and so its net debt is CN¥24.4b.

How Strong Is Kingfa Sci. & Tech's Balance Sheet?

The latest balance sheet data shows that Kingfa Sci. & Tech had liabilities of CN¥23.7b due within a year, and liabilities of CN¥20.8b falling due after that. Offsetting these obligations, it had cash of CN¥3.86b as well as receivables valued at CN¥12.6b due within 12 months. So its liabilities total CN¥28.0b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥34.6b, so it does suggest shareholders should keep an eye on Kingfa Sci. & Tech's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 7.0 hit our confidence in Kingfa Sci. & Tech like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Kingfa Sci. & Tech saw its EBIT tank 38% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Kingfa Sci. & Tech'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Kingfa Sci. & Tech 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.

Our View

To be frank both Kingfa Sci. & Tech's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. After considering the datapoints discussed, we think Kingfa Sci. & Tech has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Kingfa Sci. & Tech you should be aware of, and 1 of them is significant.

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.