A-Living Services (HKG:3319) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, A-Living Services Co., Ltd. (HKG:3319) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for A-Living Services

What Is A-Living Services's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2019 A-Living Services had debt of CN¥99.1m, up from CN¥12.0 in one year. But it also has CN¥4.59b in cash to offset that, meaning it has CN¥4.49b net cash.

How Healthy Is A-Living Services's Balance Sheet?

The latest balance sheet data shows that A-Living Services had liabilities of CN¥2.73b due within a year, and liabilities of CN¥189.1m falling due after that. Offsetting these obligations, it had cash of CN¥4.59b as well as receivables valued at CN¥1.77b due within 12 months. So it can boast CN¥3.44b more liquid assets than total liabilities.

This surplus suggests that A-Living Services has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, A-Living Services boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that A-Living Services grew its EBIT by 102% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if A-Living Services can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While A-Living Services has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, A-Living Services generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that A-Living Services has net cash of CN¥4.49b, as well as more liquid assets than liabilities. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in CN¥1.2b. So we don't think A-Living Services's use of debt is 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. Take risks, for example - A-Living Services has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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