Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Limited Kinetic Development Group (HKG:1277) uses debt in his business. But does this debt worry shareholders?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Kinetic Development Group
What is Kinetic Development Group’s net debt?
As you can see below, at the end of December 2021, Kinetic Development Group had a debt of 275.7 million Canadian yen, compared to 210.4 million domestic yen a year ago. Click on the image for more details. But on the other hand, he also has 2.66 trillion yen in cash, resulting in a net cash position of 2.38 trillion yen.
A Look at Kinetic Development Group’s Responsibilities
The latest balance sheet data shows that Kinetic Development Group had liabilities of 1.39 billion yen maturing within one year, and liabilities of 78.9 million yen maturing thereafter. On the other hand, it had a cash position of 2.66 billion Canadian yen and 243.6 million national yen of receivables due within the year. He can therefore boast of having 1.43 billion yen more in liquid assets than total Passives.
This surplus strongly suggests that Kinetic Development Group has a rock-solid balance sheet (and debt is no problem). Given this fact, we believe its balance sheet is as strong as an ox. In summary, Kinetic Development Group has clean cash, so it’s fair to say that it doesn’t have a lot of debt!
Even more impressive is the fact that Kinetic Development Group increased its EBIT by 193% year-over-year. This boost will make it even easier to pay off debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Kinetic Development Group that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a company can only repay its debts with cold hard cash, not with book profits. Kinetic Development Group may have net cash on the balance sheet, but it is always interesting to see how well the business converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its ability to manage debt. Over the past three years, Kinetic Development Group’s free cash flow has been 33% of its EBIT, less than expected. This low cash conversion makes debt management more difficult.
While we sympathize with investors who find debt a concern, you should keep in mind that Kinetic Development Group has net cash of 2.38 billion Canadian yen, as well as more liquid assets than liabilities. . And it has impressed us with its 193% EBIT growth over the past year. We therefore do not believe Kinetic Development Group’s use of debt is risky. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Kinetic Development Group you should know.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.