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. As with many other companies Hunan Kylinsec Technology Co., Ltd. (SHSE:688152) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. 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.
How Much Debt Does Hunan Kylinsec Technology Carry?
The image below, which you can click on for greater detail, shows that at September 2023 Hunan Kylinsec Technology had debt of CN¥32.9m, up from none in one year. However, its balance sheet shows it holds CN¥809.5m in cash, so it actually has CN¥776.6m net cash.
How Strong Is Hunan Kylinsec Technology's Balance Sheet?
We can see from the most recent balance sheet that Hunan Kylinsec Technology had liabilities of CN¥126.7m falling due within a year, and liabilities of CN¥29.4m due beyond that. Offsetting these obligations, it had cash of CN¥809.5m as well as receivables valued at CN¥334.2m due within 12 months. So it can boast CN¥987.6m more liquid assets than total liabilities.
It's good to see that Hunan Kylinsec Technology has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. 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 Hunan Kylinsec Technology has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Hunan Kylinsec Technology 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.
Over 12 months, Hunan Kylinsec Technology made a loss at the EBIT level, and saw its revenue drop to CN¥170m, which is a fall of 58%. To be frank that doesn't bode well.
So How Risky Is Hunan Kylinsec Technology?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Hunan Kylinsec Technology lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥57m and booked a CN¥30m accounting loss. With only CN¥776.6m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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, we've discovered 1 warning sign for Hunan Kylinsec Technology 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.