We Think Kinetic Development Group (HKG:1277) Can Manage Its Debt With Ease

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.' 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 can see that Kinetic Development Group Limited (HKG:1277) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

How Much Debt Does Kinetic Development Group Carry?

As you can see below, at the end of June 2021, Kinetic Development Group had CN¥280.6m of debt, up from CN¥228.4m a year ago. Click the image for more detail. But on the other hand it also has CN¥2.41b in cash, leading to a CN¥2.13b net cash position.

How Strong Is Kinetic Development Group's Balance Sheet?

We can see from the most recent balance sheet that Kinetic Development Group had liabilities of CN¥1.34b falling due within a year, and liabilities of CN¥75.3m due beyond that. Offsetting this, it had CN¥2.41b in cash and CN¥178.0m in receivables that were due within 12 months. So it actually has CN¥1.17b more liquid assets than total liabilities.

This surplus suggests that Kinetic Development Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Kinetic Development Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Kinetic Development Group grew its EBIT by 103% last year, which is an impressive improvement. 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. During the last three years, Kinetic Development Group generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Kinetic Development Group has CN¥2.13b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in CN¥1.9b. When it comes to Kinetic Development Group's debt, we sufficiently relaxed that our mind turns to the jacuzzi. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kinetic Development Group you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

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