LifeTech Scientific (HKG:1302) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that LifeTech Scientific Corporation (HKG:1302) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for LifeTech Scientific

What Is LifeTech Scientific's Net Debt?

As you can see below, LifeTech Scientific had CN¥174.5m of debt at December 2020, down from CN¥330.3m a year prior. However, it does have CN¥1.14b in cash offsetting this, leading to net cash of CN¥968.2m.

How Strong Is LifeTech Scientific's Balance Sheet?

The latest balance sheet data shows that LifeTech Scientific had liabilities of CN¥493.6m due within a year, and liabilities of CN¥102.5m falling due after that. On the other hand, it had cash of CN¥1.14b and CN¥194.5m worth of receivables due within a year. So it actually has CN¥741.2m more liquid assets than total liabilities.

This surplus suggests that LifeTech Scientific has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that LifeTech Scientific has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, LifeTech Scientific grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. 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'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. 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. In the last three years, LifeTech Scientific's free cash flow amounted to 38% 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 LifeTech Scientific has net cash of CN¥968.2m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 49% over the last year. So we don't think LifeTech Scientific's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that LifeTech Scientific is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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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