Is Neway Group Holdings (HKG:55) Using Debt In A Risky Way?

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.' 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. We note that Neway Group Holdings Limited (HKG:55) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Neway Group Holdings

What Is Neway Group Holdings's Debt?

The image below, which you can click on for greater detail, shows that Neway Group Holdings had debt of HK$80.1m at the end of December 2020, a reduction from HK$92.6m over a year. However, it does have HK$251.9m in cash offsetting this, leading to net cash of HK$171.9m.

How Strong Is Neway Group Holdings' Balance Sheet?

The latest balance sheet data shows that Neway Group Holdings had liabilities of HK$243.1m due within a year, and liabilities of HK$53.7m falling due after that. Offsetting this, it had HK$251.9m in cash and HK$220.9m in receivables that were due within 12 months. So it actually has HK$176.0m 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. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Neway Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Neway Group Holdings 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.

In the last year Neway Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 5.0%, to HK$533m. We would much prefer see growth.

So How Risky Is Neway Group Holdings?

Although Neway Group Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$18m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. The next few years will be important as the business matures. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Neway Group Holdings (of which 1 shouldn'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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This article by Simply Wall St is general in nature. 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.
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