These 4 Measures Indicate That NetDragon Websoft Holdings (HKG:777) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, NetDragon Websoft Holdings Limited (HKG:777) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

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What Is NetDragon Websoft Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 NetDragon Websoft Holdings had CN¥1.65b of debt, an increase on CN¥1.33b, over one year. But on the other hand it also has CN¥3.90b in cash, leading to a CN¥2.25b net cash position.

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¥2.66b due within 12 months and liabilities of CN¥1.36b due beyond that. Offsetting these obligations, it had cash of CN¥3.90b as well as receivables valued at CN¥1.44b due within 12 months. So it can boast CN¥1.32b 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!

While NetDragon Websoft Holdings doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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'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. 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 61% 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 it is always sensible to investigate a company's debt, in this case NetDragon Websoft Holdings has CN¥2.25b in net cash and a decent-looking balance sheet. So we don't think NetDragon Websoft Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with NetDragon Websoft Holdings .

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.

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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.