A-Living Smart City Services (HKG:3319) Could Easily Take On More Debt

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.' 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, A-Living Smart City Services Co., Ltd. (HKG:3319) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for A-Living Smart City Services

What Is A-Living Smart City Services's Net Debt?

As you can see below, at the end of December 2020, A-Living Smart City Services had CN¥233.7m of debt, up from CN¥76.7m a year ago. Click the image for more detail. But it also has CN¥5.65b in cash to offset that, meaning it has CN¥5.41b net cash.

How Healthy Is A-Living Smart City Services' Balance Sheet?

The latest balance sheet data shows that A-Living Smart City Services had liabilities of CN¥4.87b due within a year, and liabilities of CN¥452.4m falling due after that. Offsetting this, it had CN¥5.65b in cash and CN¥3.41b in receivables that were due within 12 months. So it can boast CN¥3.74b more liquid assets than total liabilities.

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

In addition to that, we're happy to report that A-Living Smart City Services has boosted its EBIT by 63%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine A-Living Smart City Services'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While A-Living Smart City Services 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, A-Living Smart City Services recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case A-Living Smart City Services has CN¥5.41b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.1b, being 90% of its EBIT. So we don't think A-Living Smart City Services's use of debt is risky. We'd be very excited to see if A-Living Smart City Services insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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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