We Think NetDragon Websoft Holdings (HKG:777) Can Manage Its Debt With Ease

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.' 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 is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

What Is NetDragon Websoft Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that NetDragon Websoft Holdings had CN¥1.33b of debt in June 2021, down from CN¥1.48b, one year before. However, it does have CN¥4.39b in cash offsetting this, leading to net cash of CN¥3.06b.

How Strong Is NetDragon Websoft Holdings' Balance Sheet?

We can see from the most recent balance sheet that NetDragon Websoft Holdings had liabilities of CN¥2.25b falling due within a year, and liabilities of CN¥1.23b due beyond that. On the other hand, it had cash of CN¥4.39b and CN¥1.11b worth of receivables due within a year. So it can boast CN¥2.02b more liquid assets than total liabilities.

This excess liquidity suggests that NetDragon Websoft Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that NetDragon Websoft Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that NetDragon Websoft Holdings has boosted its EBIT by 71%, 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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¥3.06b, as well as more liquid assets than liabilities. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in CN¥1.0b. The bottom line is that we do not find NetDragon Websoft Holdings's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for NetDragon Websoft Holdings that you should be aware of before investing here.

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.
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