Is Hope Education Group (HKG: 1765) a risky investment?

Warren Buffett said: “Volatility is far from synonymous with risk”. 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. Above all, Hope Education Group Co., Ltd. (HKG: 1765) carries the debt. But the most important question is: what risk does this debt create?

Why Does Debt Bring Risk?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. 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. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest review for Hope Education Group

What is Hope Education Group net debt?

You can click on the graph below for historical figures, but it shows that in August 2021, Hope Education Group had a debt of CNS 5.28 billion, an increase from CN’s 3.23 billion, on a year. However, he also had CN 4.47 billion in cash, so his net debt was CN 808.4 million.

SEHK: 1765 History of debt to equity December 20, 2021

How strong is Hope Education Group’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Hope Education Group had CN 6.88 billion in liabilities due within 12 months and CN 5.18 billion in liabilities beyond. On the other hand, he had CN 4.47 billion in cash and CN 1.05 billion in receivables due within one year. Thus, its liabilities exceed the sum of its cash and its (short-term) receivables by 6.54 b CN.

This is a mountain of leverage compared to its market cap of 8.76b CN. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe 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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Looking at its 0.83 net debt over EBITDA and 3.5 times interest coverage, it seems to us that Hope Education Group is probably using the debt in a fairly reasonable way. We therefore recommend that you keep a close eye on the impact of financing costs on the business. Notably, Hope Education Group’s EBIT was higher than Elon Musk’s, gaining a whopping 108% from last year. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Hope Education Group can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Hope Education Group’s free cash flow has been 23% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.

Our point of view

Based on our analysis, Hope Education Group’s EBIT growth rate should indicate that it will not have too many problems with its debt. However, our other observations were not so encouraging. For example, it looks like he has to struggle a bit to cover his interest costs with his EBIT. When we consider all of the factors mentioned above, we feel a little cautious about Hope Education Group’s use of debt. While debt has its advantage in potential higher returns, we believe shareholders should definitely consider how leverage levels might make the stock riskier. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. We have identified 4 warning signs with Hope Education Group, and understanding them should be part of your investment process.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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 any stock 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 material. Simply Wall St has no position in any of the stocks mentioned.

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