Is Shentong Robot Education Group (HKG:8206) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Shentong Robot Education Group Company Limited (HKG:8206) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shentong Robot Education Group

What Is Shentong Robot Education Group's Debt?

As you can see below, Shentong Robot Education Group had HK$112.6m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has HK$268.5m in cash, leading to a HK$155.9m net cash position.

A Look At Shentong Robot Education Group's Liabilities

According to the last reported balance sheet, Shentong Robot Education Group had liabilities of HK$303.4m due within 12 months, and liabilities of HK$24.6m due beyond 12 months. Offsetting this, it had HK$268.5m in cash and HK$2.15m in receivables that were due within 12 months. So its liabilities total HK$57.4m more than the combination of its cash and short-term receivables.

Shentong Robot Education Group has a market capitalization of HK$127.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Shentong Robot Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Shentong Robot Education Group's EBIT fell a jaw-dropping 91% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shentong Robot Education Group will need earnings to service that debt. 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. Shentong Robot 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, Shentong Robot 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

Although Shentong Robot 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 HK$155.9m. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in HK$26m. So we don't have any problem with Shentong Robot Education Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Shentong Robot Education Group (including 1 which can't be ignored) .

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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