Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 the more important question is: how much risk is that debt creating?
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. 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 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¥390.2m at the end of June 2023, a reduction from CN¥799.7m over a year. On the flip side, it has CN¥389.8m in cash leading to net debt of about CN¥473.0k.
A Look At CMGE Technology Group's Liabilities
Zooming in on the latest balance sheet data, we can see that CMGE Technology Group had liabilities of CN¥1.01b due within 12 months and liabilities of CN¥255.9m due beyond that. Offsetting these obligations, it had cash of CN¥389.8m as well as receivables valued at CN¥1.17b due within 12 months. So it actually has CN¥292.0m more liquid assets than total liabilities.
This surplus suggests that CMGE Technology Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, CMGE Technology Group has a very light debt load indeed.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
CMGE Technology Group's debt of just 0.0048 times EBITDA is clearly modest. But strangely, EBIT was only 0.27 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Importantly, CMGE Technology Group's EBIT fell a jaw-dropping 97% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. 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. So we always check how much of that EBIT is translated into free cash flow. 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.
Our View
To be frank both CMGE Technology Group's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making CMGE Technology Group stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Given our hesitation about the stock, it would be good to know if CMGE Technology Group insiders have sold any shares recently. You click here to find out if insiders have sold recently.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
About SEHK:302
CMGE Technology Group
An investment holding company, develops and publishes intellectual property (IP)-based games in Mainland China and internationally.
Moderate growth potential with mediocre balance sheet.