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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Minth Group Limited (HKG:425) 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Minth Group Carry?
You can click the graphic below for the historical numbers, but it shows that Minth Group had CN¥3.84b of debt in June 2019, down from CN¥4.09b, one year before. But on the other hand it also has CN¥4.75b in cash, leading to a CN¥913.0m net cash position.
How Healthy Is Minth Group's Balance Sheet?
We can see from the most recent balance sheet that Minth Group had liabilities of CN¥6.99b falling due within a year, and liabilities of CN¥201.3m due beyond that. Offsetting these obligations, it had cash of CN¥4.75b as well as receivables valued at CN¥3.18b due within 12 months. So it can boast CN¥747.4m more liquid assets than total liabilities.
This surplus suggests that Minth Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Minth Group boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Minth Group has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Minth Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Minth 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. In the last three years, Minth Group created free cash flow amounting to 5.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Minth Group has net cash of CN¥913.0m, as well as more liquid assets than liabilities. So we don't have any problem with Minth Group's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Minth Group, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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