Is MGI Tech (SHSE:688114) Using Debt In A Risky Way?

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.' 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 note that MGI Tech Co., Ltd. (SHSE:688114) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for MGI Tech

What Is MGI Tech's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 MGI Tech had debt of CN¥413.1m, up from CN¥50.0m in one year. However, it does have CN¥5.16b in cash offsetting this, leading to net cash of CN¥4.74b.

How Healthy Is MGI Tech's Balance Sheet?

We can see from the most recent balance sheet that MGI Tech had liabilities of CN¥1.33b falling due within a year, and liabilities of CN¥408.7m due beyond that. On the other hand, it had cash of CN¥5.16b and CN¥803.1m worth of receivables due within a year. So it actually has CN¥4.22b more liquid assets than total liabilities.

This excess liquidity suggests that MGI Tech is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, MGI Tech boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MGI Tech's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year MGI Tech had a loss before interest and tax, and actually shrunk its revenue by 31%, to CN¥2.9b. To be frank that doesn't bode well.

So How Risky Is MGI Tech?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that MGI Tech had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥2.7b of cash and made a loss of CN¥597m. Given it only has net cash of CN¥4.74b, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. To that end, you should be aware of the 1 warning sign we've spotted with MGI Tech .

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.