A-Living Smart City Services (HKG:3319) Seems To Use Debt Rather Sparingly

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.' 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 A-Living Smart City Services Co., Ltd. (HKG:3319) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for A-Living Smart City Services

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

The image below, which you can click on for greater detail, shows that A-Living Smart City Services had debt of CN¥61.4m at the end of June 2021, a reduction from CN¥354.7m over a year. However, its balance sheet shows it holds CN¥8.89b in cash, so it actually has CN¥8.83b net cash.

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

According to the last reported balance sheet, A-Living Smart City Services had liabilities of CN¥6.81b due within 12 months, and liabilities of CN¥507.2m due beyond 12 months. Offsetting this, it had CN¥8.89b in cash and CN¥4.33b in receivables that were due within 12 months. So it can boast CN¥5.90b more liquid assets than total liabilities.

This surplus suggests that A-Living Smart City Services is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. 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.

On top of that, A-Living Smart City Services grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. A-Living Smart City Services may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, A-Living Smart City Services recorded free cash flow worth a fulsome 97% 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 we empathize with investors who find debt concerning, you should keep in mind that A-Living Smart City Services has net cash of CN¥8.83b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.6b, being 97% of its EBIT. The bottom line is that we do not find A-Living Smart City Services's debt levels at all concerning. 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. We've identified 2 warning signs with A-Living Smart City Services , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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