Is LifeTech Scientific (HKG:1302) A Risky Investment?

Simply Wall St
November 20, 2021
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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. Importantly, LifeTech Scientific Corporation (HKG:1302) does carry debt. But should shareholders be worried about its use of debt?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for LifeTech Scientific

What Is LifeTech Scientific's Net Debt?

As you can see below, LifeTech Scientific had CN¥61.2m of debt at June 2021, down from CN¥379.0m a year prior. But it also has CN¥1.25b in cash to offset that, meaning it has CN¥1.19b net cash.

SEHK:1302 Debt to Equity History November 21st 2021

A Look At LifeTech Scientific's Liabilities

According to the last reported balance sheet, LifeTech Scientific had liabilities of CN¥414.4m due within 12 months, and liabilities of CN¥107.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.25b as well as receivables valued at CN¥219.9m due within 12 months. So it actually has CN¥947.1m more liquid assets than total liabilities.

This short term liquidity is a sign that LifeTech Scientific could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that LifeTech Scientific has more cash than debt is arguably a good indication that it can manage its debt safely.

While LifeTech Scientific doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 LifeTech Scientific can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. LifeTech Scientific 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, LifeTech Scientific recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case LifeTech Scientific has CN¥1.19b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥196m, being 84% of its EBIT. So we don't think LifeTech Scientific's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for LifeTech Scientific you should know about.

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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