Is New Century Group Hong Kong (HKG:234) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, New Century Group Hong Kong Limited (HKG:234) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for New Century Group Hong Kong

What Is New Century Group Hong Kong's Net Debt?

As you can see below, at the end of March 2023, New Century Group Hong Kong had HK$151.8m of debt, up from HK$111.8m a year ago. Click the image for more detail. But it also has HK$456.0m in cash to offset that, meaning it has HK$304.2m net cash.

A Look At New Century Group Hong Kong's Liabilities

According to the last reported balance sheet, New Century Group Hong Kong had liabilities of HK$182.9m due within 12 months, and liabilities of HK$19.0m due beyond 12 months. Offsetting this, it had HK$456.0m in cash and HK$656.1m in receivables that were due within 12 months. So it can boast HK$910.2m more liquid assets than total liabilities.

This luscious liquidity implies that New Century Group Hong Kong's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, New Century Group Hong Kong boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for New Century Group Hong Kong if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is New Century Group Hong Kong's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. New Century Group Hong Kong 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. Considering the last three years, New Century Group Hong Kong actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that New Century Group Hong Kong has net cash of HK$304.2m and plenty of liquid assets. So we are not troubled with New Century Group Hong Kong'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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for New Century Group Hong Kong (of which 1 shouldn't be ignored!) you should know about.

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.