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. As with many other companies Niche-Tech Group Limited (HKG:8490) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at 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$32.9m of debt in December 2020, down from HK$50.4m, one year before. However, its balance sheet shows it holds HK$58.8m in cash, so it actually has HK$25.8m net cash.
How Strong Is Niche-Tech Group's Balance Sheet?
The latest balance sheet data shows that Niche-Tech Group had liabilities of HK$53.8m due within a year, and liabilities of HK$19.0m falling due after that. Offsetting these obligations, it had cash of HK$58.8m as well as receivables valued at HK$83.6m due within 12 months. So it actually has HK$69.6m more liquid assets than total liabilities.
It's good to see that Niche-Tech Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Niche-Tech Group boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Niche-Tech Group'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.
In the last year Niche-Tech Group had a loss before interest and tax, and actually shrunk its revenue by 19%, to HK$172m. 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 we do note that Niche-Tech Group had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$34m and booked a HK$14m accounting loss. With only HK$25.8m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. To that end, you should learn about the 2 warning signs we've spotted with Niche-Tech Group (including 1 which doesn't sit too well with us) .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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