The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Hailiang Education Group Inc. (NASDAQ:HLG) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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, 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.
What Is Hailiang Education Group's Net Debt?
As you can see below, Hailiang Education Group had CN¥99.6m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have CN¥1.65b in cash offsetting this, leading to net cash of CN¥1.55b.
A Look At Hailiang Education Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Hailiang Education Group had liabilities of CN¥806.4m due within 12 months and liabilities of CN¥7.27m due beyond that. Offsetting this, it had CN¥1.65b in cash and CN¥83.5m in receivables that were due within 12 months. So it actually has CN¥917.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Hailiang Education Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hailiang Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Hailiang Education Group grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Hailiang Education Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hailiang Education Group 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. Over the last three years, Hailiang Education Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Hailiang Education Group has CN¥1.55b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 153% of that EBIT to free cash flow, bringing in CN¥608m. So we don't think Hailiang Education Group's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hailiang Education Group's earnings per share history for free.
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.
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