China Maple Leaf Educational Systems (HKG:1317) Could Easily Take On More Debt

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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.’ 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. China Maple Leaf Educational Systems Limited (HKG:1317) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for China Maple Leaf Educational Systems

What Is China Maple Leaf Educational Systems’s Debt?

You can click the graphic below for the historical numbers, but it shows that China Maple Leaf Educational Systems had CN¥322.4m of debt in February 2019, down from CN¥411.8m, one year before But on the other hand it also has CN¥1.77b in cash, leading to a CN¥1.45b net cash position.

SEHK:1317 Historical Debt, July 15th 2019
SEHK:1317 Historical Debt, July 15th 2019

A Look At China Maple Leaf Educational Systems’s Liabilities

According to the last reported balance sheet, China Maple Leaf Educational Systems had liabilities of CN¥1.13b due within 12 months, and liabilities of CN¥242.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.77b as well as receivables valued at CN¥72.0m due within 12 months. So it can boast CN¥469.4m more liquid assets than total liabilities.

This short term liquidity is a sign that China Maple Leaf Educational Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Given that China Maple Leaf Educational Systems has more cash than debt, we’re pretty confident it can manage its debt safely.

And we also note warmly that China Maple Leaf Educational Systems grew its EBIT by 10% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Maple Leaf Educational Systems’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. China Maple Leaf Educational Systems may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, China Maple Leaf Educational Systems 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 China Maple Leaf Educational Systems has net cash of CN¥1.5b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥545m, being 104% of its EBIT. So we don’t think China Maple Leaf Educational Systems’s use of debt is risky. We’d be very excited to see if China Maple Leaf Educational Systems insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.