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

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.' 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. Importantly, KuangChi Science Limited (HKG:439) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for KuangChi Science

How Much Debt Does KuangChi Science Carry?

You can click the graphic below for the historical numbers, but it shows that KuangChi Science had HK$158.6m of debt in June 2022, down from HK$180.9m, one year before. But it also has HK$243.1m in cash to offset that, meaning it has HK$84.5m net cash.

How Healthy Is KuangChi Science's Balance Sheet?

According to the last reported balance sheet, KuangChi Science had liabilities of HK$139.7m due within 12 months, and liabilities of HK$264.5m due beyond 12 months. Offsetting this, it had HK$243.1m in cash and HK$55.1m in receivables that were due within 12 months. So it has liabilities totalling HK$106.1m more than its cash and near-term receivables, combined.

Given KuangChi Science has a market capitalization of HK$757.3m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, KuangChi Science boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since KuangChi Science will need earnings to service that debt. 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.

In the last year KuangChi Science wasn't profitable at an EBIT level, but managed to grow its revenue by 147%, to HK$131m. So there's no doubt that shareholders are cheering for growth

So How Risky Is KuangChi Science?

Although KuangChi Science had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of 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. The good news for KuangChi Science shareholders is that its revenue growth is strong, making it easier to raise capital if need be. But that doesn't change our opinion that the stock is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example KuangChi Science has 2 warning signs (and 1 which is a bit concerning) we think 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.

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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.