Kingsoft (HKG:3888) Seems To Use Debt Rather Sparingly

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. As with many other companies Kingsoft Corporation Limited (HKG:3888) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kingsoft

How Much Debt Does Kingsoft Carry?

As you can see below, Kingsoft had CN¥2.26b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥18.8b in cash to offset that, meaning it has CN¥16.5b net cash.

How Healthy Is Kingsoft's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kingsoft had liabilities of CN¥3.70b due within 12 months and liabilities of CN¥3.63b due beyond that. On the other hand, it had cash of CN¥18.8b and CN¥881.4m worth of receivables due within a year. So it can boast CN¥12.3b 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.

The modesty of its debt load may become crucial for Kingsoft if management cannot prevent a repeat of the 43% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Kingsoft 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. While Kingsoft has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Kingsoft actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Kingsoft has CN¥16.5b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.9b, being 118% of its EBIT. So we don't think Kingsoft's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Kingsoft you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.