Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. 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 can see that CPM Group Limited (HKG:1932) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 CPM Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 CPM Group had HK$213.7m of debt, an increase on HK$189.1m, over one year. However, because it has a cash reserve of HK$146.0m, its net debt is less, at about HK$67.7m.
How Strong Is CPM Group's Balance Sheet?
The latest balance sheet data shows that CPM Group had liabilities of HK$452.8m due within a year, and liabilities of HK$13.6m falling due after that. On the other hand, it had cash of HK$146.0m and HK$358.8m worth of receivables due within a year. So it actually has HK$38.4m more liquid assets than total liabilities.
This surplus suggests that CPM Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. There's no doubt that we learn most about debt from the balance sheet. But it is CPM 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.
In the last year CPM Group had negative earnings before interest and tax, and actually shrunk its revenue by 22%, to HK$672m. To be frank that doesn't bode well.
Not only did CPM Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$139m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how CPM Group's profit, revenue, and operating cashflow have changed over the last few years.
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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