Is KuangChi Science (HKG:439) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies KuangChi Science Limited (HKG:439) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.

See our latest analysis for KuangChi Science

How Much Debt Does KuangChi Science Carry?

As you can see below, KuangChi Science had HK$496.8m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have HK$147.8m in cash offsetting this, leading to net debt of about HK$349.0m.

How Strong Is KuangChi Science's Balance Sheet?

The latest balance sheet data shows that KuangChi Science had liabilities of HK$504.4m due within a year, and liabilities of HK$400.3m falling due after that. On the other hand, it had cash of HK$147.8m and HK$206.5m worth of receivables due within a year. So it has liabilities totalling HK$550.5m more than its cash and near-term receivables, combined.

KuangChi Science has a market capitalization of HK$1.60b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is KuangChi Science's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, KuangChi Science reported revenue of HK$99m, which is a gain of 63%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate KuangChi Science's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost HK$35m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of HK$76m. So to be blunt we do think it is risky. 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. For example, we've discovered 2 warning signs for KuangChi Science (1 doesn't sit too well with us!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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