The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, INESA Intelligent Tech Inc. (SHSE:600602) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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.
What Is INESA Intelligent Tech's Debt?
The image below, which you can click on for greater detail, shows that INESA Intelligent Tech had debt of CN¥38.2m at the end of March 2024, a reduction from CN¥182.7m over a year. However, it does have CN¥3.16b in cash offsetting this, leading to net cash of CN¥3.12b.
A Look At INESA Intelligent Tech's Liabilities
The latest balance sheet data shows that INESA Intelligent Tech had liabilities of CN¥1.99b due within a year, and liabilities of CN¥100.1m falling due after that. Offsetting this, it had CN¥3.16b in cash and CN¥989.3m in receivables that were due within 12 months. So it can boast CN¥2.06b more liquid assets than total liabilities.
This surplus suggests that INESA Intelligent Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that INESA Intelligent Tech has more cash than debt is arguably a good indication that it can manage its debt safely.
Although INESA Intelligent Tech made a loss at the EBIT level, last year, it was also good to see that it generated CN¥78m in EBIT over the last twelve months. 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 INESA Intelligent Tech 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. INESA Intelligent Tech 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 year, INESA Intelligent Tech actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
While it is always sensible to investigate a company's debt, in this case INESA Intelligent Tech has CN¥3.12b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 214% of that EBIT to free cash flow, bringing in CN¥167m. So is INESA Intelligent Tech's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for INESA Intelligent Tech you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.