Maoyan Entertainment (HKG:1896) Could Easily Take On More Debt

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. We note that Maoyan Entertainment (HKG:1896) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

Check out our latest analysis for Maoyan Entertainment

What Is Maoyan Entertainment's Debt?

As you can see below, Maoyan Entertainment had CN¥100.0m of debt at June 2023, down from CN¥383.7m a year prior. However, its balance sheet shows it holds CN¥3.56b in cash, so it actually has CN¥3.46b net cash.

How Strong Is Maoyan Entertainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Maoyan Entertainment had liabilities of CN¥3.75b due within 12 months and liabilities of CN¥118.5m due beyond that. Offsetting these obligations, it had cash of CN¥3.56b as well as receivables valued at CN¥586.8m due within 12 months. So it actually has CN¥272.8m more liquid assets than total liabilities.

This surplus suggests that Maoyan Entertainment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Maoyan Entertainment boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Maoyan Entertainment grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Maoyan Entertainment can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Maoyan Entertainment 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 three years, Maoyan Entertainment actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Maoyan Entertainment has net cash of CN¥3.46b, as well as more liquid assets than liabilities. The cherry on top was that in converted 182% of that EBIT to free cash flow, bringing in CN¥1.8b. So is Maoyan Entertainment's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Maoyan Entertainment's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.