These 4 Measures Indicate That Minth Group (HKG:425) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Minth Group Limited (HKG:425) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Minth Group

What Is Minth Group's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Minth Group had debt of CN¥6.52b, up from CN¥4.14b in one year. But on the other hand it also has CN¥6.61b in cash, leading to a CN¥91.2m net cash position.

How Strong Is Minth Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Minth Group had liabilities of CN¥9.63b due within 12 months and liabilities of CN¥2.26b due beyond that. Offsetting this, it had CN¥6.61b in cash and CN¥4.06b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.22b more than its cash and near-term receivables, combined.

Given Minth Group has a market capitalization of CN¥31.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Minth Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Minth Group's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Minth Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Minth 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. In the last three years, Minth Group created free cash flow amounting to 11% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Minth Group has CN¥91.2m in net cash. So we don't have any problem with Minth Group's use of debt. 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. To that end, you should be aware of the 2 warning signs we've spotted with Minth Group .

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.

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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.
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