Is China Kepei Education Group (HKG:1890) Using Too Much Debt?

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.' 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 can see that China Kepei Education Group Limited (HKG:1890) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China Kepei Education Group

What Is China Kepei Education Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 China Kepei Education Group had CN¥385.9m of debt, an increase on CN¥100.0m, over one year. But it also has CN¥919.4m in cash to offset that, meaning it has CN¥533.5m net cash.

How Strong Is China Kepei Education Group's Balance Sheet?

We can see from the most recent balance sheet that China Kepei Education Group had liabilities of CN¥522.1m falling due within a year, and liabilities of CN¥255.4m due beyond that. Offsetting this, it had CN¥919.4m in cash and CN¥185.3m in receivables that were due within 12 months. So it actually has CN¥327.1m more liquid assets than total liabilities.

This short term liquidity is a sign that China Kepei Education Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Kepei Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, China Kepei Education Group grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. 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 Kepei 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Kepei 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 most recent three years, China Kepei Education Group recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Kepei Education Group has net cash of CN¥533.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 29% year-on-year EBIT growth. So we don't think China Kepei Education Group's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China Kepei Education Group's earnings per share history for free.

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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