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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Bright Scholar Education Holdings Limited (NYSE:BEDU) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Bright Scholar Education Holdings's Net Debt?
As you can see below, at the end of May 2019, Bright Scholar Education Holdings had CN¥49.8m of debt, up from none a year ago. Click the image for more detail. But it also has CN¥2.33b in cash to offset that, meaning it has CN¥2.28b net cash.
A Look At Bright Scholar Education Holdings's Liabilities
According to the last reported balance sheet, Bright Scholar Education Holdings had liabilities of CN¥1.48b due within 12 months, and liabilities of CN¥82.2m due beyond 12 months. Offsetting this, it had CN¥2.33b in cash and CN¥94.2m in receivables that were due within 12 months. So it can boast CN¥854.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Bright Scholar Education Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Bright Scholar Education Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Bright Scholar Education Holdings grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Bright Scholar Education Holdings 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, a company can only pay off debt with cold hard cash, not accounting profits. While Bright Scholar Education Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Bright Scholar Education Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Bright Scholar Education Holdings has net cash of CN¥2.28b, as well as more liquid assets than liabilities. The cherry on top was that in converted 143% of that EBIT to free cash flow, bringing in CN¥414m. So we don't think Bright Scholar Education Holdings's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Bright Scholar Education Holdings's earnings per share history for free.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.