Here's Why Scholar Education Group (HKG:1769) Can Manage Its Debt Responsibly

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.' 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, Scholar Education Group (HKG:1769) does carry debt. But is this debt a concern to shareholders?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Scholar Education Group

How Much Debt Does Scholar Education Group Carry?

The image below, which you can click on for greater detail, shows that Scholar Education Group had debt of CN¥54.4m at the end of December 2020, a reduction from CN¥61.4m over a year. However, it does have CN¥741.5m in cash offsetting this, leading to net cash of CN¥687.1m.

A Look At Scholar Education Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Scholar Education Group had liabilities of CN¥644.8m due within 12 months and liabilities of CN¥484.6m due beyond that. Offsetting these obligations, it had cash of CN¥741.5m as well as receivables valued at CN¥11.6m due within 12 months. So it has liabilities totalling CN¥376.3m more than its cash and near-term receivables, combined.

Of course, Scholar Education Group has a market capitalization of CN¥3.87b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Scholar Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Scholar Education Group's EBIT fell a jaw-dropping 88% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Scholar Education Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Scholar 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. Over the last three years, Scholar Education Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Scholar Education Group has CN¥687.1m in net cash. The cherry on top was that in converted 188% of that EBIT to free cash flow, bringing in CN¥189m. So we are not troubled with Scholar Education Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Scholar Education Group is showing 4 warning signs in our investment analysis , you should know about...

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.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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