Does CMGE Technology Group (HKG:302) Have A Healthy Balance Sheet?

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.' 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. 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.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CMGE Technology Group

How Much Debt Does CMGE Technology Group Carry?

The image below, which you can click on for greater detail, shows that CMGE Technology Group had debt of CN¥454.3m at the end of June 2021, a reduction from CN¥575.0m over a year. But it also has CN¥1.76b in cash to offset that, meaning it has CN¥1.30b net cash.

How Healthy Is CMGE Technology Group's Balance Sheet?

The latest balance sheet data shows that CMGE Technology Group had liabilities of CN¥1.22b due within a year, and liabilities of CN¥242.4m falling due after that. Offsetting these obligations, it had cash of CN¥1.76b as well as receivables valued at CN¥1.30b due within 12 months. So it actually has CN¥1.60b more liquid assets than total liabilities.

This excess liquidity suggests that CMGE Technology Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. 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.

Even more impressive was the fact that CMGE Technology Group grew its EBIT by 154% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CMGE Technology Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Looking at the most recent three years, CMGE Technology Group recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that CMGE Technology Group has net cash of CN¥1.30b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 154% over the last year. So we don't think CMGE Technology Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 4 warning signs we've spotted with CMGE Technology Group .

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.
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