Is the Scholar Education Group (HKG: 1769) a risky investment?

Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Above all, University education group (HKG: 1769) carries a debt. But should shareholders be concerned about its use of debt?

When Is Debt a Problem?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. 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 in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.

See our latest analysis for Scholar Education Group

How much debt does the Scholar Education Group have?

As you can see below, Scholar Education Group had a debt of CN 60.0 million in June 2021, compared to CN 121.5 million the previous year. But it also has CNS 597.0million in cash to make up for that, which means it has a net cash of CNN 537.1million.

SEHK: 1769 Debt to equity history October 29, 2021

How strong is the balance sheet of the Scholar Education Group?

Zooming in on the latest balance sheet data, we can see that Scholar Education Group had liabilities of CN 563.2 million due within 12 months and liabilities of CN 426.5 million beyond. In return, he had CND 597.0 million in cash and CNN 11.5 million in receivables due within 12 months. Its liabilities are therefore CN 381.2 million more than the combination of its cash and short-term receivables.

This shortfall is not that big as Scholar Education Group is worth CNN 677.2 million, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky. Despite its notable liabilities, Scholar Education Group has clear cash flow, so it’s fair to say that it doesn’t have a heavy debt load!

It is important to note that the EBIT of Scholar Education Group has fallen 61% in the last twelve months. If this decline continues, then it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Scholar Education Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. Scholar Education Group may have net cash on the balance sheet, but it is always interesting to consider the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Scholar Education Group has actually generated more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee costume.

In summary

Although Scholar Education Group’s balance sheet is not particularly strong, due to total liabilities it is clearly positive to see that it has a net cash position of CNN 537.1 million. The icing on the cake was that he converted 159% of that EBIT into free cash flow, which brought in CN 310 million. So while the Scholar Education Group doesn’t have a good track record, it’s certainly not so bad. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 4 warning signs for Scholar Education Group which you should know before investing here.

If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.

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

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