These 4 Measures Indicate That Oriental University City Holdings (H.K.) (HKG:8067) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Oriental University City Holdings (H.K.) Limited (HKG:8067) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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

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

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Oriental University City Holdings (H.K.) had CN¥238.0m of debt, an increase on CN¥14.9m, over one year. And it doesn't have much cash, so its net debt is about the same.

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

According to the last reported balance sheet, Oriental University City Holdings (H.K.) had liabilities of CN¥46.6m due within 12 months, and liabilities of CN¥348.0m due beyond 12 months. Offsetting this, it had CN¥2.21m in cash and CN¥10.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥381.6m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥191.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Oriental University City Holdings (H.K.) would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Oriental University City Holdings (H.K.)'s debt to EBITDA ratio of 6.1 suggests a heavy debt load, its interest coverage of 9.6 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Sadly, Oriental University City Holdings (H.K.)'s EBIT actually dropped 7.4% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Oriental University City Holdings (H.K.) recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

On the face of it, Oriental University City Holdings (H.K.)'s net debt to EBITDA 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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Oriental University City Holdings (H.K.) has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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 instance, we've identified 3 warning signs for Oriental University City Holdings (H.K.) that you should be aware of.

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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