Kingsoft (HKG:3888) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Net Debt?

As you can see below, Kingsoft had CN¥2.26b of debt at September 2020, down from CN¥3.86b a year prior. However, it does have CN¥15.9b in cash offsetting this, leading to net cash of CN¥13.6b.

How Strong Is Kingsoft's Balance Sheet?

According to the last reported balance sheet, Kingsoft had liabilities of CN¥2.58b due within 12 months, and liabilities of CN¥3.73b due beyond 12 months. Offsetting this, it had CN¥15.9b in cash and CN¥822.2m in receivables that were due within 12 months. So it actually has CN¥10.4b more liquid assets than total liabilities.

It's good to see that Kingsoft has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Kingsoft boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Kingsoft has boosted its EBIT by 72%, thus reducing the spectre of future debt repayments. 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're focused on the future you can check out this free report showing analyst profit forecasts.

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. Happily for any shareholders, Kingsoft actually produced more free cash flow than EBIT over the last two years. 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¥13.6b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.5b, being 147% of its EBIT. When it comes to Kingsoft's debt, we sufficiently relaxed that our mind turns to the jacuzzi. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Kingsoft you should know about.

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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