MS Concept (HKG:8447) Takes On Some Risk With Its Use Of Debt

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.' 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. We note that MS Concept Limited (HKG:8447) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for MS Concept

How Much Debt Does MS Concept Carry?

The image below, which you can click on for greater detail, shows that MS Concept had debt of HK$11.6m at the end of September 2020, a reduction from HK$14.2m over a year. But on the other hand it also has HK$57.7m in cash, leading to a HK$46.0m net cash position.

How Strong Is MS Concept's Balance Sheet?

According to the last reported balance sheet, MS Concept had liabilities of HK$50.3m due within 12 months, and liabilities of HK$29.7m due beyond 12 months. Offsetting this, it had HK$57.7m in cash and HK$1.49m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$20.8m.

This deficit isn't so bad because MS Concept is worth HK$40.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, MS Concept boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that MS Concept's EBIT was down 89% last year. 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 MS Concept will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. MS Concept 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, MS Concept actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While MS Concept does have more liabilities than liquid assets, it also has net cash of HK$46.0m. And it impressed us with free cash flow of HK$31m, being 260% of its EBIT. So although we see some areas for improvement, we're not too worried about MS Concept's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for MS Concept (of which 2 are potentially serious!) you should know about.

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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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.
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