Oriental University City Holdings (H.K.) (HKG:8067) Use Of Debt Could Be Considered Risky

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Oriental University City Holdings (H.K.) Limited (HKG:8067) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. 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 Debt?

As you can see below, at the end of June 2021, Oriental University City Holdings (H.K.) had CN¥281.9m of debt, up from CN¥238.0m a year ago. Click the image for more detail. On the flip side, it has CN¥28.1m in cash leading to net debt of about CN¥253.8m.

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¥77.2m due within a year, and liabilities of CN¥378.4m falling due after that. On the other hand, it had cash of CN¥28.1m and CN¥19.1m worth of receivables due within a year. So its liabilities total CN¥408.4m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥100.3m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Oriental University City Holdings (H.K.) would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 2.0 times and a disturbingly high net debt to EBITDA ratio of 9.2 hit our confidence in Oriental University City Holdings (H.K.) like a one-two punch to the gut. The debt burden here is substantial. Even worse, Oriental University City Holdings (H.K.) saw its EBIT tank 34% 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 it is Oriental University City Holdings (H.K.)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Oriental University City Holdings (H.K.) recorded free cash flow worth 76% 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.

Our View

To be frank both Oriental University City Holdings (H.K.)'s EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Oriental University City Holdings (H.K.) has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. We've identified 4 warning signs with Oriental University City Holdings (H.K.) (at least 1 which is significant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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