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Scholar Education Group (HKG:1769) Could Easily Take On More Debt

Simply Wall St

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Scholar Education Group (HKG:1769) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Scholar Education Group

What Is Scholar Education Group's Net Debt?

As you can see below, at the end of June 2019, Scholar Education Group had CN¥46.3m of debt, up from CN¥45.3 a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥599.2m in cash, so it actually has CN¥552.9m net cash.

SEHK:1769 Historical Debt, January 1st 2020

How Strong Is Scholar Education Group's Balance Sheet?

We can see from the most recent balance sheet that Scholar Education Group had liabilities of CN¥363.8m falling due within a year, and liabilities of CN¥252.9m due beyond that. Offsetting this, it had CN¥599.2m in cash and CN¥1.40m in receivables that were due within 12 months. So it has liabilities totalling CN¥16.1m more than its cash and near-term receivables, combined.

This state of affairs indicates that Scholar Education Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥5.25b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Scholar Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Scholar Education Group grew its EBIT by 15% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Scholar Education 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. Scholar 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. During the last three years, Scholar Education Group generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Scholar Education Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥552.9m. And it impressed us with free cash flow of CN¥52m, being 100% of its EBIT. So is Scholar Education Group's debt a risk? It doesn't seem so to us. 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 Scholar Education Group's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

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