Minsheng Education Group (HKG:1569) Takes On Some Risk With Its Use Of 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Minsheng Education Group Company Limited (HKG:1569) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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How Much Debt Does Minsheng Education Group Carry?

The chart below, which you can click on for greater detail, shows that Minsheng Education Group had CN¥1.81b in debt in June 2022; about the same as the year before. However, its balance sheet shows it holds CN¥2.59b in cash, so it actually has CN¥777.9m net cash.

A Look At Minsheng Education Group's Liabilities

The latest balance sheet data shows that Minsheng Education Group had liabilities of CN¥2.91b due within a year, and liabilities of CN¥3.36b falling due after that. Offsetting this, it had CN¥2.59b in cash and CN¥808.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.87b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥1.53b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Minsheng Education Group would likely require a major re-capitalisation if it had to pay its creditors today. Minsheng Education Group boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

While Minsheng Education Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Minsheng Education Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Minsheng Education Group 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. In the last three years, Minsheng Education Group's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Minsheng Education Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥777.9m. Despite its cash we think that Minsheng Education Group seems to struggle to handle its total liabilities, so we are wary of the stock. 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. Case in point: We've spotted 1 warning sign for Minsheng Education Group you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.