Is Q Technology (Group) (HKG:1478) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Q Technology (Group) Company Limited (HKG:1478) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Q Technology (Group)

What Is Q Technology (Group)'s Net Debt?

As you can see below, at the end of December 2021, Q Technology (Group) had CN¥1.76b of debt, up from CN¥1.26b a year ago. Click the image for more detail. But on the other hand it also has CN¥1.79b in cash, leading to a CN¥36.7m net cash position.

How Strong Is Q Technology (Group)'s Balance Sheet?

The latest balance sheet data shows that Q Technology (Group) had liabilities of CN¥8.08b due within a year, and liabilities of CN¥263.8m falling due after that. On the other hand, it had cash of CN¥1.79b and CN¥4.29b worth of receivables due within a year. So its liabilities total CN¥2.26b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Q Technology (Group) has a market capitalization of CN¥5.58b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Q Technology (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Q Technology (Group) saw its EBIT decline by 4.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Q Technology (Group) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Q Technology (Group) 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. Happily for any shareholders, Q Technology (Group) actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Q Technology (Group) does have more liabilities than liquid assets, it also has net cash of CN¥36.7m. The cherry on top was that in converted 266% of that EBIT to free cash flow, bringing in CN¥1.6b. So we are not troubled with Q Technology (Group)'s debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Q Technology (Group) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.