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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that V.S. International Group Limited (HKG:1002) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. 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.
What Is V.S. International Group's Debt?
You can click the graphic below for the historical numbers, but it shows that V.S. International Group had CN¥43.3m of debt in January 2022, down from CN¥96.4m, one year before. But it also has CN¥50.3m in cash to offset that, meaning it has CN¥7.07m net cash.
How Healthy Is V.S. International Group's Balance Sheet?
We can see from the most recent balance sheet that V.S. International Group had liabilities of CN¥44.4m falling due within a year, and liabilities of CN¥37.8m due beyond that. On the other hand, it had cash of CN¥50.3m and CN¥62.4m worth of receivables due within a year. So it actually has CN¥30.5m more liquid assets than total liabilities.
It's good to see that V.S. International Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that V.S. International Group has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since V.S. International 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.
Over 12 months, V.S. International Group made a loss at the EBIT level, and saw its revenue drop to CN¥201m, which is a fall of 47%. That makes us nervous, to say the least.
So How Risky Is V.S. International Group?
While V.S. International Group lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥7.6m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. We've identified 3 warning signs with V.S. International Group (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.
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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.