Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘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. We note that New Oriental Education & Technology Group Inc. (NYSE:EDU) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does New Oriental Education & Technology Group Carry?
As you can see below, at the end of August 2019, New Oriental Education & Technology Group had US$95.2m of debt, up from none a year ago. Click the image for more detail. But it also has US$3.34b in cash to offset that, meaning it has US$3.24b net cash.
A Look At New Oriental Education & Technology Group’s Liabilities
We can see from the most recent balance sheet that New Oriental Education & Technology Group had liabilities of US$2.42b falling due within a year, and liabilities of US$983.7m due beyond that. Offsetting these obligations, it had cash of US$3.34b as well as receivables valued at US$50.3m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that New Oriental Education & Technology 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 US$19.2b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, New Oriental Education & Technology Group boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, New Oriental Education & Technology Group grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if New Oriental Education & Technology Group can strengthen its balance sheet over time. 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. While New Oriental Education & Technology 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, New Oriental Education & Technology 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 look at a company’s total liabilities, it is very reassuring that New Oriental Education & Technology Group has US$3.24b in net cash. And it impressed us with free cash flow of US$529m, being 175% of its EBIT. So is New Oriental Education & Technology 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 New Oriental Education & Technology 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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