Is China Maple Leaf Educational Systems (HKG:1317) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, China Maple Leaf Educational Systems Limited (HKG:1317) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Maple Leaf Educational Systems

How Much Debt Does China Maple Leaf Educational Systems Carry?

You can click the graphic below for the historical numbers, but it shows that as of February 2024 China Maple Leaf Educational Systems had CN¥3.68b of debt, an increase on CN¥3.48b, over one year. However, because it has a cash reserve of CN¥631.8m, its net debt is less, at about CN¥3.05b.

A Look At China Maple Leaf Educational Systems' Liabilities

We can see from the most recent balance sheet that China Maple Leaf Educational Systems had liabilities of CN¥2.67b falling due within a year, and liabilities of CN¥2.00b due beyond that. Offsetting this, it had CN¥631.8m in cash and CN¥228.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.81b.

This deficit casts a shadow over the CN¥675.2m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, China Maple Leaf Educational Systems would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

China Maple Leaf Educational Systems has a rather high debt to EBITDA ratio of 6.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 6.5 times, suggesting it can responsibly service its obligations. Notably, China Maple Leaf Educational Systems's EBIT launched higher than Elon Musk, gaining a whopping 101% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is China Maple Leaf Educational Systems's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. 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.

Our View

While China Maple Leaf Educational Systems's level of total liabilities has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that China Maple Leaf Educational Systems is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that China Maple Leaf Educational Systems is showing 3 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com