Does Kingsoft (HKG:3888) Have A Healthy Balance Sheet?

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 Kingsoft Corporation Limited (HKG:3888) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Kingsoft

What Is Kingsoft's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Kingsoft had debt of CN¥2.57b, up from CN¥2.26b in one year. But it also has CN¥21.5b in cash to offset that, meaning it has CN¥19.0b net cash.

How Strong Is Kingsoft's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kingsoft had liabilities of CN¥4.15b due within 12 months and liabilities of CN¥3.31b due beyond that. On the other hand, it had cash of CN¥21.5b and CN¥853.3m worth of receivables due within a year. So it actually has CN¥14.9b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kingsoft's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Kingsoft has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Kingsoft grew its EBIT by 50% 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 it is future earnings, more than anything, that will determine Kingsoft's ability to maintain a healthy balance sheet going forward. 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. Kingsoft 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. Happily for any shareholders, Kingsoft actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Kingsoft has net cash of CN¥19.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 161% of that EBIT to free cash flow, bringing in CN¥2.2b. The bottom line is that Kingsoft's use of debt is absolutely fine. 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. We've identified 1 warning sign with Kingsoft , and understanding them should be part of your investment process.

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.