We Think NOVA Group Holdings (HKG:1360) Can Manage Its Debt With Ease

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that NOVA Group Holdings Limited (HKG:1360) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for NOVA Group Holdings

What Is NOVA Group Holdings's Debt?

As you can see below, NOVA Group Holdings had HK$40.5m of debt at December 2021, down from HK$171.5m a year prior. But on the other hand it also has HK$91.6m in cash, leading to a HK$51.1m net cash position.

A Look At NOVA Group Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that NOVA Group Holdings had liabilities of HK$61.2m due within 12 months and liabilities of HK$3.81m due beyond that. On the other hand, it had cash of HK$91.6m and HK$459.3m worth of receivables due within a year. So it can boast HK$485.8m 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!

In addition to that, we're happy to report that NOVA Group Holdings has boosted its EBIT by 95%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since NOVA Group Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While NOVA Group Holdings 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. Looking at the most recent three years, NOVA Group Holdings recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case NOVA Group Holdings has HK$51.1m in net cash and a strong balance sheet. And it impressed us with its EBIT growth of 95% over the last year. So is NOVA Group Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for NOVA Group Holdings that you should be aware of.

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.