These 4 Measures Indicate That Vobile Group (HKG:3738) Is Using Debt Reasonably Well

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.' 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. We note that Vobile Group Limited (HKG:3738) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

View our latest analysis for Vobile Group

What Is Vobile Group's Net Debt?

The image below, which you can click on for greater detail, shows that Vobile Group had debt of HK$546.8m at the end of June 2023, a reduction from HK$964.9m over a year. On the flip side, it has HK$248.2m in cash leading to net debt of about HK$298.6m.

A Look At Vobile Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Vobile Group had liabilities of HK$724.2m due within 12 months and liabilities of HK$563.6m due beyond that. Offsetting these obligations, it had cash of HK$248.2m as well as receivables valued at HK$966.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$73.3m.

Having regard to Vobile Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$5.13b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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).

Given net debt is only 1.2 times EBITDA, it is initially surprising to see that Vobile Group's EBIT has low interest coverage of 1.6 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Pleasingly, Vobile Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 274% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Vobile Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Vobile Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Vobile Group's conversion of EBIT to free cash flow was a real negative on this analysis, as was its interest cover. But its EBIT growth rate was significantly redeeming. Looking at all this data makes us feel a little cautious about Vobile Group's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Vobile Group , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.