Is Quali-Smart Holdings (HKG:1348) Using Too Much 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.' 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 note that Quali-Smart Holdings Limited (HKG:1348) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Quali-Smart Holdings

What Is Quali-Smart Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Quali-Smart Holdings had HK$92.4m of debt in September 2020, down from HK$125.3m, one year before. However, it also had HK$73.2m in cash, and so its net debt is HK$19.2m.

How Healthy Is Quali-Smart Holdings's Balance Sheet?

We can see from the most recent balance sheet that Quali-Smart Holdings had liabilities of HK$330.2m falling due within a year, and liabilities of HK$32.4m due beyond that. On the other hand, it had cash of HK$73.2m and HK$182.3m worth of receivables due within a year. So its liabilities total HK$107.1m more than the combination of its cash and short-term receivables.

Quali-Smart Holdings has a market capitalization of HK$464.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Quali-Smart 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.

In the last year Quali-Smart Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 4.8%, to HK$454m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Quali-Smart Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$18m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$3.3m in negative free cash flow over the last twelve months. So to be blunt we think it 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Quali-Smart Holdings you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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