Here's Why Cornerstone Technologies Holdings (HKG:8391) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Cornerstone Technologies Holdings Limited (HKG:8391) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Cornerstone Technologies Holdings

What Is Cornerstone Technologies Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Cornerstone Technologies Holdings had HK$28.2m of debt in December 2021, down from HK$36.1m, one year before. However, because it has a cash reserve of HK$17.3m, its net debt is less, at about HK$10.8m.

How Healthy Is Cornerstone Technologies Holdings' Balance Sheet?

According to the last reported balance sheet, Cornerstone Technologies Holdings had liabilities of HK$56.9m due within 12 months, and liabilities of HK$51.5m due beyond 12 months. Offsetting this, it had HK$17.3m in cash and HK$10.1m in receivables that were due within 12 months. So it has liabilities totalling HK$80.9m more than its cash and near-term receivables, combined.

Since publicly traded Cornerstone Technologies Holdings shares are worth a total of HK$577.4m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cornerstone Technologies Holdings'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, Cornerstone Technologies Holdings made a loss at the EBIT level, and saw its revenue drop to HK$52m, which is a fall of 9.8%. That's not what we would hope to see.

Caveat Emptor

Importantly, Cornerstone Technologies Holdings had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$72m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$75m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Cornerstone Technologies Holdings (including 2 which don't sit too well with us) .

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. 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.