Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Range Intelligent Computing Technology Group Company Limited (SZSE:300442) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Range Intelligent Computing Technology Group's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Range Intelligent Computing Technology Group had debt of CN¥11.0b, up from CN¥9.77b in one year. However, it does have CN¥2.42b in cash offsetting this, leading to net debt of about CN¥8.58b.
How Strong Is Range Intelligent Computing Technology Group's Balance Sheet?
The latest balance sheet data shows that Range Intelligent Computing Technology Group had liabilities of CN¥4.26b due within a year, and liabilities of CN¥13.0b falling due after that. Offsetting this, it had CN¥2.42b in cash and CN¥1.39b in receivables that were due within 12 months. So it has liabilities totalling CN¥13.4b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Range Intelligent Computing Technology Group is worth CN¥40.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Range Intelligent Computing Technology Group's net debt is 3.6 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 21.0 is very high, suggesting that the interest expense on the debt is currently quite low. It is well worth noting that Range Intelligent Computing Technology Group's EBIT shot up like bamboo after rain, gaining 51% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Range Intelligent Computing Technology Group's ability to maintain a healthy balance sheet going forward. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Range Intelligent Computing Technology Group saw substantial negative free cash flow, in total. 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
Based on what we've seen Range Intelligent Computing Technology Group is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Range Intelligent Computing Technology Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Range Intelligent Computing Technology Group (including 2 which don't sit too well with us) .
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.
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