Netjoy Holdings (HKG:2131) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Netjoy Holdings Limited (HKG:2131) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Netjoy Holdings

What Is Netjoy Holdings's Debt?

The image below, which you can click on for greater detail, shows that Netjoy Holdings had debt of CN¥451.5m at the end of June 2024, a reduction from CN¥601.4m over a year. But on the other hand it also has CN¥482.8m in cash, leading to a CN¥31.4m net cash position.

A Look At Netjoy Holdings' Liabilities

We can see from the most recent balance sheet that Netjoy Holdings had liabilities of CN¥1.41b falling due within a year, and liabilities of CN¥8.46m due beyond that. Offsetting this, it had CN¥482.8m in cash and CN¥1.66b in receivables that were due within 12 months. So it can boast CN¥731.4m more liquid assets than total liabilities.

This surplus liquidity suggests that Netjoy Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Netjoy Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Netjoy Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥9.7m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Netjoy Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Netjoy 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. Over the last year, Netjoy Holdings 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.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Netjoy Holdings has net cash of CN¥31.4m and plenty of liquid assets. So we don't have any problem with Netjoy Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Netjoy Holdings has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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.