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Is Momo (NASDAQ:MOMO) Using Too Much Debt?

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·4 min read
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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. Importantly, Momo Inc. (NASDAQ:MOMO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Momo

What Is Momo's Net Debt?

As you can see below, Momo had CN¥4.66b of debt at December 2020, down from CN¥4.95b a year prior. However, its balance sheet shows it holds CN¥10.9b in cash, so it actually has CN¥6.27b net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Momo's Liabilities

We can see from the most recent balance sheet that Momo had liabilities of CN¥2.52b falling due within a year, and liabilities of CN¥5.87b due beyond that. On the other hand, it had cash of CN¥10.9b and CN¥200.8m worth of receivables due within a year. So it actually has CN¥2.75b more liquid assets than total liabilities.

This short term liquidity is a sign that Momo could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Momo 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 Momo if management cannot prevent a repeat of the 29% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Momo'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Momo 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. Happily for any shareholders, Momo actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Momo has net cash of CN¥6.27b, as well as more liquid assets than liabilities. The cherry on top was that in converted 121% of that EBIT to free cash flow, bringing in CN¥3.0b. So we are not troubled with Momo's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Momo 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.