These 4 Measures Indicate That Kingsoft (HKG:3888) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Kingsoft Corporation Limited (HKG:3888) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for Kingsoft

What Is Kingsoft's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Kingsoft had CN¥2.59b of debt, an increase on CN¥2.26b, over one year. But it also has CN¥19.8b in cash to offset that, meaning it has CN¥17.3b net cash.

How Strong Is Kingsoft's Balance Sheet?

The latest balance sheet data shows that Kingsoft had liabilities of CN¥3.93b due within a year, and liabilities of CN¥3.27b falling due after that. Offsetting this, it had CN¥19.8b in cash and CN¥914.3m in receivables that were due within 12 months. So it actually has CN¥13.6b 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. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Kingsoft has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Kingsoft saw its EBIT drop by 6.9% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. 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 we empathize with investors who find debt concerning, you should keep in mind that Kingsoft has net cash of CN¥17.3b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.9b, being 197% of its EBIT. So we don't think Kingsoft's use of debt is risky. We'd be very excited to see if Kingsoft insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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. 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.