KuangChi Science (HKG:439) Has Debt But No Earnings; Should You Worry?

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. We note that KuangChi Science Limited (HKG:439) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for KuangChi Science

How Much Debt Does KuangChi Science Carry?

The image below, which you can click on for greater detail, shows that KuangChi Science had debt of HK$178.0m at the end of December 2021, a reduction from HK$496.8m over a year. But on the other hand it also has HK$343.6m in cash, leading to a HK$165.6m net cash position.

A Look At KuangChi Science's Liabilities

Zooming in on the latest balance sheet data, we can see that KuangChi Science had liabilities of HK$187.0m due within 12 months and liabilities of HK$358.7m due beyond that. Offsetting these obligations, it had cash of HK$343.6m as well as receivables valued at HK$82.0m due within 12 months. So it has liabilities totalling HK$120.0m more than its cash and near-term receivables, combined.

Since publicly traded KuangChi Science shares are worth a total of HK$843.5m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, KuangChi Science also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since KuangChi Science will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year KuangChi Science wasn't profitable at an EBIT level, but managed to grow its revenue by 15%, to HK$114m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is KuangChi Science?

While KuangChi Science lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$83m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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 KuangChi Science (of which 1 is a bit unpleasant!) you should know about.

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.