These 4 Measures Indicate That CMGE Technology Group (HKG:302) Is Using Debt Safely

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, CMGE Technology Group Limited (HKG:302) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for CMGE Technology Group

How Much Debt Does CMGE Technology Group Carry?

The chart below, which you can click on for greater detail, shows that CMGE Technology Group had CN¥451.4m in debt in December 2020; about the same as the year before. But it also has CN¥907.3m in cash to offset that, meaning it has CN¥456.0m net cash.

How Healthy Is CMGE Technology Group's Balance Sheet?

We can see from the most recent balance sheet that CMGE Technology Group had liabilities of CN¥1.46b falling due within a year, and liabilities of CN¥65.9m due beyond that. Offsetting these obligations, it had cash of CN¥907.3m as well as receivables valued at CN¥896.0m due within 12 months. So it can boast CN¥273.5m 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. Succinctly put, CMGE Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that CMGE Technology Group has boosted its EBIT by 64%, thus reducing the spectre of future debt repayments. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CMGE Technology Group 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 most recent three years, CMGE Technology Group recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case CMGE Technology Group has CN¥456.0m in net cash and a decent-looking balance sheet. And we liked the look of last year's 64% year-on-year EBIT growth. So is CMGE Technology Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for CMGE Technology Group (of which 1 makes us a bit uncomfortable!) 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.

If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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