We Think A-Living Smart City Services (HKG:3319) Can Stay On Top Of Its 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 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 A-Living Smart City Services Co., Ltd. (HKG:3319) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for A-Living Smart City Services

How Much Debt Does A-Living Smart City Services Carry?

You can click the graphic below for the historical numbers, but it shows that A-Living Smart City Services had CN¥147.7m of debt in June 2023, down from CN¥235.4m, one year before. However, its balance sheet shows it holds CN¥5.76b in cash, so it actually has CN¥5.61b net cash.

How Healthy Is A-Living Smart City Services' Balance Sheet?

We can see from the most recent balance sheet that A-Living Smart City Services had liabilities of CN¥8.30b falling due within a year, and liabilities of CN¥515.6m due beyond that. Offsetting these obligations, it had cash of CN¥5.76b as well as receivables valued at CN¥9.59b due within 12 months. So it can boast CN¥6.54b more liquid assets than total liabilities.

This luscious liquidity implies that A-Living Smart City Services' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, A-Living Smart City Services boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for A-Living Smart City Services if management cannot prevent a repeat of the 47% 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if A-Living Smart City Services 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While A-Living Smart City Services 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. Looking at the most recent three years, A-Living Smart City Services recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case A-Living Smart City Services has CN¥5.61b in net cash and a strong balance sheet. So we are not troubled with A-Living Smart City Services's debt use. 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. For example - A-Living Smart City Services has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.