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. We can see that Computime Group Limited (HKG:320) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Computime Group's Debt?
The image below, which you can click on for greater detail, shows that Computime Group had debt of HK$210.0m at the end of March 2019, a reduction from HK$250.7m over a year. However, it does have HK$436.5m in cash offsetting this, leading to net cash of HK$226.4m.
A Look At Computime Group's Liabilities
The latest balance sheet data shows that Computime Group had liabilities of HK$903.2m due within a year, and liabilities of HK$24.5m falling due after that. Offsetting this, it had HK$436.5m in cash and HK$605.9m in receivables that were due within 12 months. So it can boast HK$114.7m more liquid assets than total liabilities.
This excess liquidity suggests that Computime Group is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Computime Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Importantly, Computime Group's EBIT fell a jaw-dropping 80% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Computime Group will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. Computime 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, Computime 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 Computime Group has HK$226m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in -HK$74.7m. So we don't have any problem with Computime Group's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Computime 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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