Health Check: How Prudently Does Neway Group Holdings (HKG:55) Use Debt?

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.' 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. Importantly, Neway Group Holdings Limited (HKG:55) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Neway Group Holdings

How Much Debt Does Neway Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Neway Group Holdings had HK$102.6m of debt, an increase on HK$88.8m, over one year. But on the other hand it also has HK$213.5m in cash, leading to a HK$110.9m net cash position.

How Healthy Is Neway Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Neway Group Holdings had liabilities of HK$254.1m due within 12 months and liabilities of HK$50.4m due beyond that. On the other hand, it had cash of HK$213.5m and HK$222.3m worth of receivables due within a year. So it can boast HK$131.3m more liquid assets than total liabilities.

This surplus liquidity suggests that Neway Group Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Neway Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Neway Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Neway Group Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 14%, to HK$604m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Neway Group Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Neway Group Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$31m and booked a HK$28m accounting loss. Given it only has net cash of HK$110.9m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. For instance, we've identified 2 warning signs for Neway Group Holdings (1 is a bit concerning) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.