Hello Group (NASDAQ:MOMO) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hello Group Inc. (NASDAQ:MOMO) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hello Group

What Is Hello Group's Net Debt?

As you can see below, Hello Group had CN¥4.62b of debt at June 2021, down from CN¥5.04b a year prior. But it also has CN¥9.57b in cash to offset that, meaning it has CN¥4.95b net cash.

How Healthy Is Hello Group's Balance Sheet?

The latest balance sheet data shows that Hello Group had liabilities of CN¥2.35b due within a year, and liabilities of CN¥5.00b falling due after that. Offsetting this, it had CN¥9.57b in cash and CN¥217.1m in receivables that were due within 12 months. So it actually has CN¥2.43b more liquid assets than total liabilities.

This short term liquidity is a sign that Hello Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hello Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Hello Group's load is not too heavy, because its EBIT was down 37% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hello Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hello Group 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. Over the last three years, Hello Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Hello Group has net cash of CN¥4.95b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.0b, being 114% of its EBIT. So we don't have any problem with Hello Group'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. Case in point: We've spotted 1 warning sign for Hello Group you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.