Kingsoft (HKG:3888) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Kingsoft Corporation Limited (HKG:3888) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kingsoft

What Is Kingsoft's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Kingsoft had debt of CN¥2.41b, up from CN¥2.23b in one year. But it also has CN¥19.4b in cash to offset that, meaning it has CN¥17.0b net cash.

How Healthy Is Kingsoft's Balance Sheet?

According to the last reported balance sheet, Kingsoft had liabilities of CN¥3.97b due within 12 months, and liabilities of CN¥3.79b due beyond 12 months. On the other hand, it had cash of CN¥19.4b and CN¥836.0m worth of receivables due within a year. So it actually has CN¥12.5b more liquid assets than total liabilities.

This surplus liquidity suggests that Kingsoft's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Kingsoft has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Kingsoft has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, Kingsoft actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Kingsoft has CN¥17.0b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in CN¥2.0b. So we don't think Kingsoft's use of debt is risky. 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. For instance, we've identified 2 warning signs for Kingsoft 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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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.