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. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Meilleure Health International Industry Group Limited (HKG:2327) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Meilleure Health International Industry Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Meilleure Health International Industry Group had HK$376.2m of debt, an increase on HK$211.3m, over one year. But on the other hand it also has HK$430.5m in cash, leading to a HK$54.2m net cash position.
A Look At Meilleure Health International Industry Group's Liabilities
We can see from the most recent balance sheet that Meilleure Health International Industry Group had liabilities of HK$300.9m falling due within a year, and liabilities of HK$355.4m due beyond that. Offsetting this, it had HK$430.5m in cash and HK$82.7m in receivables that were due within 12 months. So it has liabilities totalling HK$143.1m more than its cash and near-term receivables, combined.
Given Meilleure Health International Industry Group has a market capitalization of HK$2.18b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Meilleure Health International Industry Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Pleasingly, Meilleure Health International Industry Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 369% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Meilleure Health International Industry Group's ability to maintain a healthy balance sheet going forward. 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 Meilleure Health International Industry 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, Meilleure Health International Industry Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
We could understand if investors are concerned about Meilleure Health International Industry Group's liabilities, but we can be reassured by the fact it has has net cash of HK$54.2m. And it impressed us with its EBIT growth of 369% over the last year. So we are not troubled with Meilleure Health International Industry Group's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Meilleure Health International Industry Group insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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