Capinfo (HKG:1075) 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 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 note that Capinfo Company Limited (HKG:1075) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Capinfo

What Is Capinfo's Net Debt?

The image below, which you can click on for greater detail, shows that Capinfo had debt of CN¥224.5m at the end of June 2021, a reduction from CN¥252.1m over a year. However, it does have CN¥896.6m in cash offsetting this, leading to net cash of CN¥672.1m.

How Strong Is Capinfo's Balance Sheet?

The latest balance sheet data shows that Capinfo had liabilities of CN¥1.24b due within a year, and liabilities of CN¥51.7m falling due after that. On the other hand, it had cash of CN¥896.6m and CN¥497.7m worth of receivables due within a year. So it actually has CN¥99.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Capinfo could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Capinfo has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Capinfo grew its EBIT by 4.9% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Capinfo will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Capinfo 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, Capinfo 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 Capinfo has CN¥672.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in CN¥81m. So we don't think Capinfo'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. For example, we've discovered 2 warning signs for Capinfo that you should be aware of before investing here.

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.
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