Is Oriental University City Holdings (H.K.) (HKG:8067) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Oriental University City Holdings (H.K.) Limited (HKG:8067) does have debt on its balance sheet. 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. 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.

Check out our latest analysis for Oriental University City Holdings (H.K.)

What Is Oriental University City Holdings (H.K.)'s Net Debt?

The image below, which you can click on for greater detail, shows that Oriental University City Holdings (H.K.) had debt of CN¥221.0m at the end of December 2022, a reduction from CN¥265.4m over a year. However, it does have CN¥9.12m in cash offsetting this, leading to net debt of about CN¥211.9m.

How Healthy Is Oriental University City Holdings (H.K.)'s Balance Sheet?

The latest balance sheet data shows that Oriental University City Holdings (H.K.) had liabilities of CN¥75.5m due within a year, and liabilities of CN¥367.5m falling due after that. Offsetting this, it had CN¥9.12m in cash and CN¥11.1m in receivables that were due within 12 months. So its liabilities total CN¥422.8m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥87.0m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Oriental University City Holdings (H.K.) would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 8.3 hit our confidence in Oriental University City Holdings (H.K.) like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Oriental University City Holdings (H.K.) saw its EBIT tank 27% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Oriental University City Holdings (H.K.) will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Oriental University City Holdings (H.K.) produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Oriental University City Holdings (H.K.)'s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. After considering the datapoints discussed, we think Oriental University City Holdings (H.K.) has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. We've identified 4 warning signs with Oriental University City Holdings (H.K.) (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.

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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.