Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Asiainfo Technologies Limited (HKG:1675) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Asiainfo Technologies's Net Debt?
The image below, which you can click on for greater detail, shows that Asiainfo Technologies had debt of CN¥137.0m at the end of December 2020, a reduction from CN¥594.4m over a year. But it also has CN¥2.93b in cash to offset that, meaning it has CN¥2.80b net cash.
A Look At Asiainfo Technologies' Liabilities
We can see from the most recent balance sheet that Asiainfo Technologies had liabilities of CN¥3.08b falling due within a year, and liabilities of CN¥240.9m due beyond that. Offsetting these obligations, it had cash of CN¥2.93b as well as receivables valued at CN¥2.71b due within 12 months. So it actually has CN¥2.33b more liquid assets than total liabilities.
This excess liquidity suggests that Asiainfo Technologies is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Asiainfo Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Asiainfo Technologies grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. 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 Asiainfo Technologies 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 Asiainfo Technologies 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, Asiainfo Technologies actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While we empathize with investors who find debt concerning, you should keep in mind that Asiainfo Technologies has net cash of CN¥2.80b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥668m, being 108% of its EBIT. The bottom line is that we do not find Asiainfo Technologies's debt levels at all concerning. 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 - Asiainfo Technologies has 2 warning signs we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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