We Think Vongroup (HKG:318) 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.' 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, Vongroup Limited (HKG:318) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Vongroup

How Much Debt Does Vongroup Carry?

As you can see below, Vongroup had HK$23.2m of debt at October 2020, down from HK$25.3m a year prior. However, its balance sheet shows it holds HK$88.8m in cash, so it actually has HK$65.6m net cash.

How Healthy Is Vongroup's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vongroup had liabilities of HK$38.4m due within 12 months and liabilities of HK$859.0k due beyond that. Offsetting these obligations, it had cash of HK$88.8m as well as receivables valued at HK$73.8m due within 12 months. So it actually has HK$123.4m more liquid assets than total liabilities.

This surplus liquidity suggests that Vongroup's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Vongroup 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 Vongroup has boosted its EBIT by 78%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Vongroup's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Vongroup 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. During the last three years, Vongroup burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Vongroup has HK$65.6m in net cash and a strong balance sheet. And it impressed us with its EBIT growth of 78% over the last year. So is Vongroup's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Vongroup you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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