Is MeiG Smart Technology (SZSE:002881) A Risky Investment?

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 MeiG Smart Technology Co., Ltd (SZSE:002881) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for MeiG Smart Technology

What Is MeiG Smart Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that MeiG Smart Technology had CN¥73.0m of debt in September 2023, down from CN¥373.3m, one year before. However, its balance sheet shows it holds CN¥255.6m in cash, so it actually has CN¥182.6m net cash.

How Strong Is MeiG Smart Technology's Balance Sheet?

According to the last reported balance sheet, MeiG Smart Technology had liabilities of CN¥637.1m due within 12 months, and liabilities of CN¥48.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥255.6m as well as receivables valued at CN¥684.6m due within 12 months. So it can boast CN¥254.5m more liquid assets than total liabilities.

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

The modesty of its debt load may become crucial for MeiG Smart Technology if management cannot prevent a repeat of the 58% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if MeiG Smart 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MeiG Smart Technology 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. Over the last three years, MeiG Smart Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case MeiG Smart Technology has CN¥182.6m in net cash and a decent-looking balance sheet. So while MeiG Smart Technology does not have a great balance sheet, it's certainly not too bad. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for MeiG Smart Technology (of which 1 shouldn't be ignored!) you should know about.

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.