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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Hello Group Inc. (NASDAQ:MOMO) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Hello Group's Debt?
You can click the graphic below for the historical numbers, but it shows that Hello Group had CN¥4.62b of debt in June 2021, down from CN¥5.04b, one year before. But on the other hand it also has CN¥9.57b in cash, leading to a CN¥4.95b net cash position.
How Healthy Is Hello Group's Balance Sheet?
The latest balance sheet data shows that Hello Group had liabilities of CN¥2.35b due within a year, and liabilities of CN¥5.00b falling due after that. Offsetting these obligations, it had cash of CN¥9.57b as well as receivables valued at CN¥217.1m due within 12 months. So it can boast CN¥2.43b more liquid assets than total liabilities.
This surplus suggests that Hello Group is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Hello Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Hello Group if management cannot prevent a repeat of the 37% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hello Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Hello 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. Happily for any shareholders, Hello Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case Hello Group has CN¥4.95b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 114% of that EBIT to free cash flow, bringing in CN¥2.0b. So we don't think Hello Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Hello Group that you should be aware of before investing here.
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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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