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.' 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. Importantly, Minsheng Education Group Company Limited (HKG:1569) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Minsheng Education Group Carry?
As you can see below, at the end of December 2018, Minsheng Education Group had CN¥228.6m of debt, up from CN¥174.1m a year ago. Click the image for more detail. However, it does have CN¥1.52b in cash offsetting this, leading to net cash of CN¥1.29b.
How Strong Is Minsheng Education Group's Balance Sheet?
According to the last reported balance sheet, Minsheng Education Group had liabilities of CN¥1.51b due within 12 months, and liabilities of CN¥1.59b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.52b as well as receivables valued at CN¥22.4m due within 12 months. So its liabilities total CN¥1.56b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Minsheng Education Group has a market capitalization of CN¥5.05b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Minsheng Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Minsheng Education Group grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Minsheng Education 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. Minsheng 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 most recent three years, Minsheng Education Group recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although Minsheng Education Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.3b. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in -CN¥113.6m. So we don't think Minsheng Education Group's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Minsheng Education Group's earnings per share history for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.