Here's Why CMGE Technology Group (HKG:302) Has A Meaningful Debt Burden

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.' 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. As with many other companies CMGE Technology Group Limited (HKG:302) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that 302 is potentially undervalued!

How Much Debt Does CMGE Technology Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 CMGE Technology Group had CN¥799.7m of debt, an increase on CN¥454.3m, over one year. However, its balance sheet shows it holds CN¥863.0m in cash, so it actually has CN¥63.3m net cash.

How Strong Is CMGE Technology Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CMGE Technology Group had liabilities of CN¥1.81b due within 12 months and liabilities of CN¥87.2m due beyond that. Offsetting these obligations, it had cash of CN¥863.0m as well as receivables valued at CN¥1.12b due within 12 months. So it can boast CN¥88.9m 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. Succinctly put, CMGE Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for CMGE Technology Group if management cannot prevent a repeat of the 74% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. 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. Over the last three years, CMGE Technology 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case CMGE Technology Group has CN¥63.3m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about CMGE Technology Group's balance sheet. 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 instance, we've identified 2 warning signs for CMGE Technology Group that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.