MegaStudyEdu (KOSDAQ:215200) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that MegaStudyEdu Co. Ltd (KOSDAQ:215200) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for MegaStudyEdu

What Is MegaStudyEdu's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 MegaStudyEdu had debt of ₩5.09b, up from ₩954.9m in one year. However, it does have ₩21.5b in cash offsetting this, leading to net cash of ₩16.4b.

How Healthy Is MegaStudyEdu's Balance Sheet?

According to the last reported balance sheet, MegaStudyEdu had liabilities of ₩147.6b due within 12 months, and liabilities of ₩50.6b due beyond 12 months. Offsetting these obligations, it had cash of ₩21.5b as well as receivables valued at ₩30.8b due within 12 months. So its liabilities total ₩145.9b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since MegaStudyEdu has a market capitalization of ₩521.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, MegaStudyEdu also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for MegaStudyEdu if management cannot prevent a repeat of the 45% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if MegaStudyEdu can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. MegaStudyEdu may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, MegaStudyEdu's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While MegaStudyEdu does have more liabilities than liquid assets, it also has net cash of ₩16.4b. So we don't have any problem with MegaStudyEdu's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for MegaStudyEdu that you should be aware of.

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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