These 4 Measures Indicate That Man Yue Technology Holdings (HKG:894) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 can see that Man Yue Technology Holdings Limited (HKG:894) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Man Yue Technology Holdings

What Is Man Yue Technology Holdings's Net Debt?

As you can see below, at the end of June 2021, Man Yue Technology Holdings had HK$1.12b of debt, up from HK$1.02b a year ago. Click the image for more detail. On the flip side, it has HK$223.0m in cash leading to net debt of about HK$896.2m.

How Healthy Is Man Yue Technology Holdings' Balance Sheet?

We can see from the most recent balance sheet that Man Yue Technology Holdings had liabilities of HK$1.68b falling due within a year, and liabilities of HK$107.3m due beyond that. Offsetting these obligations, it had cash of HK$223.0m as well as receivables valued at HK$857.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$705.4m.

Given this deficit is actually higher than the company's market capitalization of HK$556.4m, we think shareholders really should watch Man Yue Technology Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Man Yue Technology Holdings's debt is 4.8 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Man Yue Technology Holdings's EBIT launched higher than Elon Musk, gaining a whopping 650% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Man Yue Technology Holdings will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Man Yue Technology Holdings 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

We'd go so far as to say Man Yue Technology Holdings's conversion of EBIT to free cash flow was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Man Yue Technology Holdings has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Man Yue Technology Holdings (of which 1 doesn't sit too well with us!) you should know about.

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.

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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