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.' 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. Importantly, Microware Group Limited (HKG:1985) does carry debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Microware Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Microware Group had HK$599.0k of debt, an increase on none, over one year. But it also has HK$252.4m in cash to offset that, meaning it has HK$251.8m net cash.
A Look At Microware Group's Liabilities
According to the last reported balance sheet, Microware Group had liabilities of HK$298.8m due within 12 months, and liabilities of HK$5.31m due beyond 12 months. Offsetting this, it had HK$252.4m in cash and HK$207.7m in receivables that were due within 12 months. So it can boast HK$156.0m more liquid assets than total liabilities.
This surplus liquidity suggests that Microware Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Microware Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Microware Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Microware Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Microware Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Microware Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case Microware Group has HK$252m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$45m, being 109% of its EBIT. When it comes to Microware Group's debt, we sufficiently relaxed that our mind turns to the jacuzzi. Another factor that would give us confidence in Microware Group would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.