NetDragon Websoft Holdings (HKG:777) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 NetDragon Websoft Holdings Limited (HKG:777) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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, 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.

Check out our latest analysis for NetDragon Websoft Holdings

How Much Debt Does NetDragon Websoft Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 NetDragon Websoft Holdings had CN¥2.07b of debt, an increase on CN¥1.49b, over one year. However, it does have CN¥3.99b in cash offsetting this, leading to net cash of CN¥1.92b.

How Strong Is NetDragon Websoft Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NetDragon Websoft Holdings had liabilities of CN¥2.96b due within 12 months and liabilities of CN¥1.47b due beyond that. Offsetting these obligations, it had cash of CN¥3.99b as well as receivables valued at CN¥1.24b due within 12 months. So it actually has CN¥801.0m more liquid assets than total liabilities.

This short term liquidity is a sign that NetDragon Websoft Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, NetDragon Websoft Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that NetDragon Websoft Holdings has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 NetDragon Websoft Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. NetDragon Websoft Holdings 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. During the last three years, NetDragon Websoft Holdings produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that NetDragon Websoft Holdings has net cash of CN¥1.92b, as well as more liquid assets than liabilities. So we are not troubled with NetDragon Websoft Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for NetDragon Websoft Holdings 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.