Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Niche-Tech Group Limited (HKG:8490) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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.
How Much Debt Does Niche-Tech Group Carry?
You can click the graphic below for the historical numbers, but it shows that Niche-Tech Group had HK$26.3m of debt in June 2020, down from HK$50.4m, one year before. However, its balance sheet shows it holds HK$57.6m in cash, so it actually has HK$31.3m net cash.
How Healthy Is Niche-Tech Group's Balance Sheet?
The latest balance sheet data shows that Niche-Tech Group had liabilities of HK$40.6m due within a year, and liabilities of HK$19.0m falling due after that. On the other hand, it had cash of HK$57.6m and HK$75.4m worth of receivables due within a year. So it can boast HK$73.3m more liquid assets than total liabilities.
This surplus liquidity suggests that Niche-Tech Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Niche-Tech Group has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Niche-Tech Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Niche-Tech Group had a loss before interest and tax, and actually shrunk its revenue by 12%, to HK$175m. That's not what we would hope to see.
So How Risky Is Niche-Tech Group?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Niche-Tech Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of HK$18m and booked a HK$8.1m accounting loss. Given it only has net cash of HK$31.3m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Niche-Tech Group (at least 1 which is potentially serious) , 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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Niche-Tech Semiconductor Materials
Niche-Tech Semiconductor Materials Limited, an investment holding company, develops, manufactures, and sells semiconductor packaging materials in the People’s Republic of China and Hong Kong.
Excellent balance sheet with acceptable track record.