The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Meilleure Health International Industry Group Limited (HKG:2327) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is Meilleure Health International Industry Group's Debt?
As you can see below, Meilleure Health International Industry Group had HK$238.1m of debt at June 2020, down from HK$376.2m a year prior. However, its balance sheet shows it holds HK$361.2m in cash, so it actually has HK$123.0m net cash.
How Healthy Is Meilleure Health International Industry Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Meilleure Health International Industry Group had liabilities of HK$184.0m due within 12 months and liabilities of HK$185.3m due beyond that. Offsetting this, it had HK$361.2m in cash and HK$235.5m in receivables that were due within 12 months. So it actually has HK$227.4m more liquid assets than total liabilities.
It's good to see that Meilleure Health International Industry Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Meilleure Health International Industry Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Meilleure Health International Industry Group's EBIT was down 33% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Meilleure Health International Industry Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Meilleure Health International Industry 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. During the last three years, Meilleure Health International Industry Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Meilleure Health International Industry Group has net cash of HK$123.0m, as well as more liquid assets than liabilities. So while Meilleure Health International Industry Group does not have a great balance sheet, it's certainly not too bad. Given our hesitation about the stock, it would be good to know if Meilleure Health International Industry Group insiders have sold any shares recently. You click here to find out if insiders have sold recently.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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