Does NOVA Group Holdings (HKG:1360) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that NOVA Group Holdings Limited (HKG:1360) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for NOVA Group Holdings

How Much Debt Does NOVA Group Holdings Carry?

The image below, which you can click on for greater detail, shows that NOVA Group Holdings had debt of HK$171.5m at the end of December 2020, a reduction from HK$343.3m over a year. However, its balance sheet shows it holds HK$178.3m in cash, so it actually has HK$6.74m net cash.

How Healthy Is NOVA Group Holdings' Balance Sheet?

The latest balance sheet data shows that NOVA Group Holdings had liabilities of HK$224.3m due within a year, and liabilities of HK$4.99m falling due after that. Offsetting this, it had HK$178.3m in cash and HK$405.2m in receivables that were due within 12 months. So it can boast HK$354.2m more liquid assets than total liabilities.

This surplus strongly suggests that NOVA Group Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, NOVA Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, NOVA Group Holdings's EBIT fell a jaw-dropping 84% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is NOVA Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. NOVA Group Holdings 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. In the last three years, NOVA Group Holdings created free cash flow amounting to 19% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case NOVA Group Holdings has HK$6.74m in net cash and a strong balance sheet. So we are not troubled with NOVA Group Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 4 warning signs we've spotted with NOVA Group Holdings .

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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