Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies CMGE Technology Group Limited (HKG:302) makes use of debt. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for CMGE Technology Group
What Is CMGE Technology Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that CMGE Technology Group had CN¥390.2m of debt in June 2023, down from CN¥799.7m, one year before. On the flip side, it has CN¥389.8m in cash leading to net debt of about CN¥473.0k.
How Healthy Is CMGE Technology Group's Balance Sheet?
According to the last reported balance sheet, CMGE Technology Group had liabilities of CN¥1.01b due within 12 months, and liabilities of CN¥255.9m due beyond 12 months. On the other hand, it had cash of CN¥389.8m and CN¥1.17b worth of receivables due within a year. So it actually has CN¥292.0m more liquid assets than total liabilities.
This surplus suggests that CMGE Technology Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, CMGE Technology Group has a very light debt load indeed.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
CMGE Technology Group has a net debt to EBITDA ratio of 0.0048, suggesting a very conservative balance sheet. But strangely, EBIT was only 0.27 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Shareholders should be aware that CMGE Technology Group's EBIT was down 97% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 CMGE Technology 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, CMGE Technology Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both CMGE Technology Group's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making CMGE Technology Group stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Given our hesitation about the stock, it would be good to know if CMGE Technology Group insiders have sold any shares recently. You click here to find out if insiders have sold recently.
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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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.