New Century Group Hong Kong (HKG:234) Seems To Use Debt Rather Sparingly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. As with many other companies New Century Group Hong Kong Limited (HKG:234) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for New Century Group Hong Kong

What Is New Century Group Hong Kong's Debt?

You can click the graphic below for the historical numbers, but it shows that New Century Group Hong Kong had HK$131.8m of debt in September 2019, down from HK$193.2m, one year before. But on the other hand it also has HK$579.6m in cash, leading to a HK$447.8m net cash position.

How Strong Is New Century Group Hong Kong's Balance Sheet?

We can see from the most recent balance sheet that New Century Group Hong Kong had liabilities of HK$195.6m falling due within a year, and liabilities of HK$23.2m due beyond that. Offsetting this, it had HK$579.6m in cash and HK$489.5m in receivables that were due within 12 months. So it can boast HK$850.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that New Century Group Hong Kong's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, New Century Group Hong Kong boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact New Century Group Hong Kong's saving grace is its low debt levels, because its EBIT has tanked 66% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is New Century Group Hong Kong'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.

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. Over the last three years, New Century Group Hong Kong actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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$447.8m and plenty of liquid assets. And it impressed us with free cash flow of HK$245m, being 276% of its EBIT. So is New Century Group Hong Kong's debt a risk? It doesn't seem so to us. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with New Century Group Hong Kong , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.