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. We note that China Information Technology Development Limited (HKG:8178) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company’s use of debt, we first look at cash and debt together.
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How Much Debt Does China Information Technology Development Carry?
As you can see below, China Information Technology Development had HK$60.7m of debt at June 2023, down from HK$135.5m a year prior. However, it also had HK$50.1m in cash, and so its net debt is HK$10.6m.
How Strong Is China Information Technology Development’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Information Technology Development had liabilities of HK$158.1m due within 12 months and liabilities of HK$16.5m due beyond that. Offsetting this, it had HK$50.1m in cash and HK$46.3m in receivables that were due within 12 months. So it has liabilities totalling HK$78.2m more than its cash and near-term receivables, combined.
This deficit isn’t so bad because China Information Technology Development is worth HK$185.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since China Information Technology Development will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Given it has no significant operating revenue at the moment, shareholders will be hoping China Information Technology Development can make progress and gain better traction for the business, before it runs low on cash.
Over the last twelve months China Information Technology Development produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$24m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn’t help that it burned through HK$19m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we’ve discovered 4 warning signs for China Information Technology Development (1 doesn’t sit too well with us!) that you should be aware of before investing here.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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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.