Kinetic Development Group (HKG:1277) Could Easily Take On More Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Kinetic Development Group Limited (HKG:1277) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Kinetic Development Group

What Is Kinetic Development Group's Net Debt?

As you can see below, at the end of December 2021, Kinetic Development Group had CN¥275.7m of debt, up from CN¥210.4m a year ago. Click the image for more detail. But on the other hand it also has CN¥2.66b in cash, leading to a CN¥2.38b net cash position.

A Look At Kinetic Development Group's Liabilities

The latest balance sheet data shows that Kinetic Development Group had liabilities of CN¥1.39b due within a year, and liabilities of CN¥78.9m falling due after that. On the other hand, it had cash of CN¥2.66b and CN¥243.6m worth of receivables due within a year. So it can boast CN¥1.43b more liquid assets than total liabilities.

This surplus strongly suggests that Kinetic Development Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Kinetic Development Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Kinetic Development Group grew its EBIT by 193% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Kinetic Development Group'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Kinetic Development 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. In the last three years, Kinetic Development Group's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kinetic Development Group has net cash of CN¥2.38b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 193% over the last year. So we don't think Kinetic Development Group's use of debt 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Kinetic Development Group 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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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.