Does VPower Group International Holdings (HKG:1608) Have A Healthy Balance Sheet?

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 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. Importantly, VPower Group International Holdings Limited (HKG:1608) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for VPower Group International Holdings

What Is VPower Group International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that VPower Group International Holdings had debt of HK$3.75b at the end of June 2020, a reduction from HK$4.22b over a year. On the flip side, it has HK$921.3m in cash leading to net debt of about HK$2.83b.

A Look At VPower Group International Holdings's Liabilities

We can see from the most recent balance sheet that VPower Group International Holdings had liabilities of HK$3.43b falling due within a year, and liabilities of HK$2.57b due beyond that. On the other hand, it had cash of HK$921.3m and HK$849.2m worth of receivables due within a year. So its liabilities total HK$4.23b more than the combination of its cash and short-term receivables.

VPower Group International Holdings has a market capitalization of HK$7.68b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about VPower Group International Holdings's net debt to EBITDA ratio of 3.8, we think its super-low interest cover of 1.7 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. More concerning, VPower Group International Holdings saw its EBIT drop by 6.6% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine VPower Group International Holdings'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, VPower Group International Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, VPower Group International Holdings's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. We're quite clear that we consider VPower Group International Holdings to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for VPower Group International Holdings (of which 1 can't be ignored!) you should know about.

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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