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.’ 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 China Information Technology Development Limited (HKG:8178) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for China Information Technology Development
What Is China Information Technology Development’s Net Debt?
As you can see below, at the end of June 2022, China Information Technology Development had HK$135.5m of debt, up from HK$91.0m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$30.6m, its net debt is less, at about HK$105.0m.
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$87.4m due within 12 months and liabilities of HK$84.4m due beyond that. Offsetting these obligations, it had cash of HK$30.6m as well as receivables valued at HK$42.9m due within 12 months. So it has liabilities totalling HK$98.3m more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company’s market capitalization of HK$81.8m, we think shareholders really should watch China Information Technology Development’s debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. 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.
It seems likely shareholders hope that China Information Technology Development can significantly advance the business plan before too long, because it doesn’t have any significant revenue at the moment.
Importantly, China Information Technology Development had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$32m. Considering that alongside the liabilities mentioned above make us nervous about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$5.2m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. For instance, we’ve identified 2 warning signs for China Information Technology Development that you should be aware of.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Discounted cash flow calculation for every stock
Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.