These 4 Measures Indicate That Meitu (HKG:1357) Is Using Debt Safely

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Meitu, Inc. (HKG:1357) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Meitu had CN¥20.0m of debt, an increase on CN¥10.0m, over one year. But on the other hand it also has CN¥1.24b in cash, leading to a CN¥1.22b net cash position.

How Healthy Is Meitu's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Meitu had liabilities of CN¥1.14b due within 12 months and liabilities of CN¥215.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.24b as well as receivables valued at CN¥985.8m due within 12 months. So it can boast CN¥867.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Meitu could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Meitu has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Meitu turned things around in the last 12 months, delivering and EBIT of CN¥101m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Meitu'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Meitu 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. Happily for any shareholders, Meitu actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Meitu has CN¥1.22b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥437m, being 432% of its EBIT. So we don't think Meitu's use of debt is risky. 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...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.