Quali-Smart Holdings (HKG:1348) Is Making Moderate Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. 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.

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Quali-Smart Holdings

What Is Quali-Smart Holdings's Debt?

The image below, which you can click on for greater detail, shows that Quali-Smart Holdings had debt of HK$92.4m at the end of September 2020, a reduction from HK$125.3m over a year. However, because it has a cash reserve of HK$73.2m, its net debt is less, at about HK$19.2m.

How Strong Is Quali-Smart Holdings' Balance Sheet?

According to the last reported balance sheet, Quali-Smart Holdings had liabilities of HK$330.2m due within 12 months, and liabilities of HK$32.4m due beyond 12 months. Offsetting these obligations, it had cash of HK$73.2m as well as receivables valued at HK$182.3m due within 12 months. So it has liabilities totalling HK$107.1m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Quali-Smart Holdings is worth HK$434.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Quali-Smart Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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

Over the last twelve months Quali-Smart Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$18m 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. 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. 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 be aware of the 1 warning sign we've spotted with Quali-Smart Holdings .

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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