David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Infotmic Co.,Ltd (SZSE:000670) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does InfotmicLtd Carry?
As you can see below, at the end of December 2023, InfotmicLtd had CN¥472.2m of debt, up from CN¥234.5m a year ago. Click the image for more detail. On the flip side, it has CN¥16.6m in cash leading to net debt of about CN¥455.5m.
A Look At InfotmicLtd's Liabilities
Zooming in on the latest balance sheet data, we can see that InfotmicLtd had liabilities of CN¥1.59b due within 12 months and liabilities of CN¥77.2m due beyond that. On the other hand, it had cash of CN¥16.6m and CN¥1.08b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥564.3m.
Since publicly traded InfotmicLtd shares are worth a total of CN¥3.97b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 9.3 hit our confidence in InfotmicLtd like a one-two punch to the gut. The debt burden here is substantial. Worse, InfotmicLtd's EBIT was down 49% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is InfotmicLtd's earnings that will influence how the balance sheet holds up in the future. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, InfotmicLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
On the face of it, InfotmicLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. We're quite clear that we consider InfotmicLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 1 warning sign with InfotmicLtd , and understanding them should be part of your investment process.
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.