NetDragon Websoft Holdings (HKG:777) Has A Rock Solid 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 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. We can see that NetDragon Websoft Holdings Limited (HKG:777) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for NetDragon Websoft Holdings

What Is NetDragon Websoft Holdings's Debt?

As you can see below, at the end of December 2020, NetDragon Websoft Holdings had CN¥1.34b of debt, up from CN¥407.2m a year ago. Click the image for more detail. But it also has CN¥4.15b in cash to offset that, meaning it has CN¥2.82b net cash.

A Look At NetDragon Websoft Holdings' Liabilities

The latest balance sheet data shows that NetDragon Websoft Holdings had liabilities of CN¥1.96b due within a year, and liabilities of CN¥1.38b falling due after that. Offsetting these obligations, it had cash of CN¥4.15b as well as receivables valued at CN¥974.2m due within 12 months. So it can boast CN¥1.79b more liquid assets than total liabilities.

This excess liquidity suggests that NetDragon Websoft Holdings is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, NetDragon Websoft Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that NetDragon Websoft Holdings has increased its EBIT by 4.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if NetDragon Websoft Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While NetDragon Websoft Holdings 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 most recent three years, NetDragon Websoft Holdings recorded free cash flow worth 73% 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 NetDragon Websoft Holdings has CN¥2.82b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.0b, being 73% of its EBIT. So we don't think NetDragon Websoft Holdings's use of debt is risky. 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. Be aware that NetDragon Websoft Holdings is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.