We Think Ruicheng (China) Media Group (HKG:1640) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Ruicheng (China) Media Group Limited (HKG:1640) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Ruicheng (China) Media Group

What Is Ruicheng (China) Media Group's Debt?

As you can see below, at the end of December 2020, Ruicheng (China) Media Group had CN¥125.5m of debt, up from CN¥98.3m a year ago. Click the image for more detail. However, it also had CN¥17.8m in cash, and so its net debt is CN¥107.7m.

How Healthy Is Ruicheng (China) Media Group's Balance Sheet?

The latest balance sheet data shows that Ruicheng (China) Media Group had liabilities of CN¥139.8m due within a year, and liabilities of CN¥50.3m falling due after that. Offsetting these obligations, it had cash of CN¥17.8m as well as receivables valued at CN¥374.2m due within 12 months. So it actually has CN¥201.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that Ruicheng (China) Media Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.9 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in Ruicheng (China) Media Group like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Ruicheng (China) Media Group's EBIT was down 77% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ruicheng (China) Media Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ruicheng (China) Media Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Ruicheng (China) Media Group's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But the good news is it seems to be able to handle its total liabilities with ease. Taking the abovementioned factors together we do think Ruicheng (China) Media Group's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 example, we've discovered 6 warning signs for Ruicheng (China) Media Group (2 are a bit concerning!) that you should be aware of before investing here.

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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