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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that China 21st Century Education Group Limited (HKG:1598) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 China 21st Century Education Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 China 21st Century Education Group had CN¥133.5m of debt, an increase on CN¥28.0m, over one year. However, its balance sheet shows it holds CN¥453.6m in cash, so it actually has CN¥320.0m net cash.
A Look At China 21st Century Education Group's Liabilities
Zooming in on the latest balance sheet data, we can see that China 21st Century Education Group had liabilities of CN¥232.1m due within 12 months and liabilities of CN¥56.2m due beyond that. Offsetting these obligations, it had cash of CN¥453.6m as well as receivables valued at CN¥64.0m due within 12 months. So it actually has CN¥229.3m more liquid assets than total liabilities.
It's good to see that China 21st Century Education Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, China 21st Century Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that China 21st Century Education Group has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China 21st Century Education Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. China 21st Century Education Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, China 21st Century Education Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that China 21st Century Education Group has net cash of CN¥320.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 121% of that EBIT to free cash flow, bringing in CN¥35m. The bottom line is that we do not find China 21st Century Education Group's debt levels at all concerning. Over time, share prices tend to follow earnings per share, so if you're interested in China 21st Century Education Group, you may well want to click here to check an interactive graph of its earnings per share history.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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