CMGE Technology Group (HKG:302) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies CMGE Technology Group Limited (HKG:302) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for CMGE Technology Group

How Much Debt Does CMGE Technology Group Carry?

As you can see below, at the end of December 2021, CMGE Technology Group had CN¥764.6m of debt, up from CN¥451.4m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.19b in cash, leading to a CN¥428.6m net cash position.

How Strong Is CMGE Technology Group's Balance Sheet?

We can see from the most recent balance sheet that CMGE Technology Group had liabilities of CN¥1.79b falling due within a year, and liabilities of CN¥259.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.19b as well as receivables valued at CN¥1.06b due within 12 months. So it actually has CN¥208.9m more liquid assets than total liabilities.

This short term liquidity is a sign that CMGE Technology Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that CMGE Technology Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that CMGE Technology Group grew its EBIT at 18% over the last year, further increasing its ability to manage debt. 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 CMGE Technology Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While CMGE Technology Group 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. In the last three years, CMGE Technology Group created free cash flow amounting to 13% 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 CMGE Technology Group has CN¥428.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 18% year-on-year EBIT growth. So we don't have any problem with CMGE Technology Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example CMGE Technology Group has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.