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.' 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. We can see that Minth Group Limited (HKG:425) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. 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?
As you can see below, Minth Group had CN¥3.84b of debt at June 2019, down from CN¥4.09b a year prior. But on the other hand it also has CN¥4.75b in cash, leading to a CN¥913.0m net cash position.
How Strong Is Minth Group's Balance Sheet?
According to the last reported balance sheet, Minth Group had liabilities of CN¥6.99b due within 12 months, and liabilities of CN¥201.3m due beyond 12 months. 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 short term liquidity is a sign that Minth Group could probably pay off its debt with ease, as its balance sheet is far from stretched. 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. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Minth Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last three years, Minth Group recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While we empathize with investors who find debt concerning, you should keep in mind that Minth Group has net cash of CN¥913m, as well as more liquid assets than liabilities. So we don't have any problem with Minth Group's use of debt. 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 Minth Group's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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