Kinetic Mines and Energy (HKG:1277) Has A Rock Solid Balance Sheet

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.' 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 Kinetic Mines and Energy Limited (HKG:1277) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Kinetic Mines and Energy

What Is Kinetic Mines and Energy's Debt?

The image below, which you can click on for greater detail, shows that Kinetic Mines and Energy had debt of CN¥210.4m at the end of December 2020, a reduction from CN¥357.7m over a year. But on the other hand it also has CN¥1.34b in cash, leading to a CN¥1.13b net cash position.

How Healthy Is Kinetic Mines and Energy's Balance Sheet?

We can see from the most recent balance sheet that Kinetic Mines and Energy had liabilities of CN¥854.7m falling due within a year, and liabilities of CN¥58.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.34b as well as receivables valued at CN¥172.2m due within 12 months. So it actually has CN¥602.9m more liquid assets than total liabilities.

It's good to see that Kinetic Mines and Energy has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Kinetic Mines and Energy has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Kinetic Mines and Energy grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Kinetic Mines and Energy 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Kinetic Mines and Energy 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. Over the last three years, Kinetic Mines and Energy recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually 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 Mines and Energy has CN¥1.13b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in CN¥1.1b. So is Kinetic Mines and Energy's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Kinetic Mines and Energy that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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