Is New Universe Environmental Group (HKG:436) Using Too Much Debt?

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 should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for New Universe Environmental Group

What Is New Universe Environmental Group's Debt?

As you can see below, New Universe Environmental Group had HK$44.0m of debt at December 2023, down from HK$98.0m a year prior. But on the other hand it also has HK$186.4m in cash, leading to a HK$142.4m net cash position.

How Healthy Is New Universe Environmental Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that New Universe Environmental Group had liabilities of HK$250.0m due within 12 months and liabilities of HK$38.1m due beyond that. Offsetting this, it had HK$186.4m in cash and HK$103.7m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that New Universe Environmental Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the HK$191.2m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that New Universe Environmental Group has more cash than debt is arguably a good indication that 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 89% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since New Universe Environmental 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 company can only pay off debt with cold hard cash, not accounting profits. 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. Happily for any shareholders, New Universe Environmental Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that New Universe Environmental Group has net cash of HK$142.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 119% of that EBIT to free cash flow, bringing in -HK$73k. 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for New Universe Environmental Group (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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. 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.