Here's Why New Universe Environmental Group (HKG:436) Can Manage Its Debt Responsibly

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 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. We can see that New Universe Environmental Group Limited (HKG:436) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for New Universe Environmental Group

How Much Debt Does New Universe Environmental Group Carry?

You can click the graphic below for the historical numbers, but it shows that New Universe Environmental Group had HK$182.3m of debt in June 2022, down from HK$216.5m, one year before. However, its balance sheet shows it holds HK$310.4m in cash, so it actually has HK$128.1m net cash.

A Look At New Universe Environmental Group's Liabilities

Zooming in on the latest balance sheet data, we can see that New Universe Environmental Group had liabilities of HK$513.9m due within 12 months and liabilities of HK$44.7m due beyond that. Offsetting these obligations, it had cash of HK$310.4m as well as receivables valued at HK$202.0m due within 12 months. So its liabilities total HK$46.2m more than the combination of its cash and short-term receivables.

Given New Universe Environmental Group has a market capitalization of HK$570.7m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, New Universe Environmental Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that New Universe Environmental Group's load is not too heavy, because its EBIT was down 79% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since New Universe Environmental 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While New Universe Environmental 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, New Universe Environmental Group generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that New Universe Environmental Group has HK$128.1m in net cash. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in HK$21m. So we don't have any problem with New Universe Environmental Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for New Universe Environmental Group (1 is a bit unpleasant!) that you should be aware of before investing here.

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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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.