Does Meitu (HKG:1357) Have A 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.' 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, Meitu, Inc. (HKG:1357) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

See our latest analysis for Meitu

What Is Meitu's Net Debt?

As you can see below, at the end of June 2024, Meitu had CN¥229.2m of debt, up from CN¥20.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.26b in cash, so it actually has CN¥1.03b net cash.

A Look At Meitu's Liabilities

According to the last reported balance sheet, Meitu had liabilities of CN¥1.69b due within 12 months, and liabilities of CN¥248.3m due beyond 12 months. On the other hand, it had cash of CN¥1.26b and CN¥465.2m worth of receivables due within a year. So it has liabilities totalling CN¥214.6m more than its cash and near-term receivables, combined.

This state of affairs indicates that Meitu's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥12.3b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Meitu boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Meitu grew its EBIT by 337% 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 ultimately the future profitability of the business will decide if Meitu can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Meitu 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. Over the last two years, Meitu 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

We could understand if investors are concerned about Meitu's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.03b. The cherry on top was that in converted 168% of that EBIT to free cash flow, bringing in CN¥478m. So is Meitu'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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Meitu is showing 2 warning signs in our investment analysis , 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.