Dongyue Group (HKG:189) Has A Pretty Healthy Balance Sheet

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.' 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 Dongyue Group Limited (HKG:189) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that 189 is potentially undervalued!

How Much Debt Does Dongyue Group Carry?

The image below, which you can click on for greater detail, shows that Dongyue Group had debt of CN¥670.6m at the end of June 2022, a reduction from CN¥2.00b over a year. However, its balance sheet shows it holds CN¥5.91b in cash, so it actually has CN¥5.24b net cash.

How Healthy Is Dongyue Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dongyue Group had liabilities of CN¥6.26b due within 12 months and liabilities of CN¥870.7m due beyond that. On the other hand, it had cash of CN¥5.91b and CN¥2.65b worth of receivables due within a year. So it can boast CN¥1.43b more liquid assets than total liabilities.

This surplus suggests that Dongyue Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Dongyue Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Dongyue Group grew its EBIT by 229% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dongyue Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Dongyue Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Dongyue Group's free cash flow amounted to 20% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Dongyue Group has net cash of CN¥5.24b, as well as more liquid assets than liabilities. And we liked the look of last year's 229% year-on-year EBIT growth. So we don't think Dongyue Group's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Dongyue Group (of which 2 make us uncomfortable!) 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. 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.