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 JH Educational Technology INC. (HKG:1935) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is JH Educational Technology’s Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 JH Educational Technology had debt of CN¥109.0m, up from CN¥255 in one year. However, its balance sheet shows it holds CN¥842.7m in cash, so it actually has CN¥733.7m net cash.
How Strong Is JH Educational Technology’s Balance Sheet?
We can see from the most recent balance sheet that JH Educational Technology had liabilities of CN¥232.0m falling due within a year, and liabilities of CN¥13.4m due beyond that. Offsetting this, it had CN¥842.7m in cash and CN¥2.89m in receivables that were due within 12 months. So it actually has CN¥600.3m more liquid assets than total liabilities.
This surplus suggests that JH Educational Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, JH Educational Technology boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, JH Educational Technology grew its EBIT by 79% over the last twelve months, and that growth will make it easier to handle its debt. 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 JH Educational Technology’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. JH Educational Technology 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, JH Educational Technology 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.
While it is always sensible to investigate a company’s debt, in this case JH Educational Technology has CN¥733.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 127% of that EBIT to free cash flow, bringing in CN¥158m. The bottom line is that we do not find JH Educational Technology’s debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Consider risks, for instance. Every company has them, and we’ve spotted 2 warning signs for JH Educational Technology you should know about.
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.
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