Does China Education Group Holdings (HKG: 839) have a healthy balance sheet?

Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies China Education Group Holdings Limited (HKG: 839) uses debt. But should shareholders be concerned about its use of debt?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution of a business with the ability to reinvest at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

Check out our latest analysis for China Education Group Holdings

What is the net debt of China Education Group Holdings?

As you can see below, at the end of August 2021, China Education Group Holdings was in debt of 8.33 billion yen, up from 5.11 billion yen a year ago. Click on the image for more details. However, it has CN 5.63 billion in cash offsetting this, which leads to net debt of around CN 2.71 billion.

SEHK: 839 History of debt to equity November 28, 2021

How healthy is China Education Group Holdings’ balance sheet?

Zooming in on the latest balance sheet data, we can see that China Education Group Holdings had CN 6.25 billion in liabilities due within 12 months and CNN 8.74 billion in liabilities beyond. In compensation for these obligations, he had cash of CNS 5.63 billion as well as receivables valued at CN 70.4 million due within 12 months. Its liabilities are therefore CNN 9.29 billion more than the combination of its cash and short-term receivables.

China Education Group Holdings has a market capitalization of CN ¥ 28.5 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.

We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

We would say that China Education Group Holdings’ moderate net debt to EBITDA ratio (being 1.5) indicates debt prudence. And its imposing EBIT of 12.5 times its interest costs, means the debt load is as light as a peacock feather. On top of that, we are happy to report that China Education Group Holdings has increased its EBIT by 40%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine China Education Group Holdings’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. In the past three years, China Education Group Holdings has reported free cash flow of 14% of its EBIT, which is really quite low. This low level of cash conversion undermines its ability to manage and repay its debts.

Our point of view

Fortunately, China Education Group Holdings’ impressive interest coverage means it has the upper hand on its debt. But, on a darker note, we’re a little concerned about its conversion from EBIT to free cash flow. All these things considered, it looks like China Education Group Holdings can comfortably manage its current debt levels. On the plus side, this leverage can increase returns to shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Be aware that China Education Group Holdings displays 2 warning signs in our investment analysis , you must know…

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

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