Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We notice that CA Cultural Technology Group Limited (HKG: 1566) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own 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) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for CA Cultural Technology Group
How much debt does CA Cultural Technology Group have?
As you can see below, CA Cultural Technology Group was in debt of HK $ 558.1 million in September 2021, up from HK $ 594.3 million the year before. On the other hand, he has HK $ 23.1million in cash, resulting in net debt of around HK $ 535.0million.
How strong is the balance sheet of CA Cultural Technology Group?
The latest balance sheet data shows that CA Cultural Technology Group had debts of HK $ 531.0 million due within one year, and debts of HK $ 444.0 million due thereafter. In compensation for these obligations, he had cash of HK $ 23.1 million as well as receivables valued at HK $ 757.3 million due within 12 months. Its liabilities therefore total HK $ 194.6 million more than the combination of its cash and short-term receivables.
This shortfall is not that big as CA Cultural Technology Group is worth HK $ 487.6 million, and therefore could possibly raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). 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).
While we’re not worried about CA Cultural Technology Group’s net debt to EBITDA ratio of 3.1, we do think its ultra-low 1.2 times interest coverage is a sign of high leverage. It appears the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. However, the bright side is that CA Cultural Technology Group achieved a positive EBIT of HK $ 78 million over the past twelve months, an improvement over the loss of the previous year. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since CA Cultural Technology Group will need revenue to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent profit before interest and taxes (EBIT) is supported by free cash flow. Over the past year, CA Cultural Technology Group has actually generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.
Our point of view
Based on what we’ve seen, CA Cultural Technology Group doesn’t find it easy, given its coverage of interest, but the other factors we’ve taken into account give us cause for optimism. There is no doubt that its ability to convert EBIT to free cash flow is quite fast. Looking at all of this data, we feel a little cautious about the debt levels of CA Cultural Technology Group. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt level closely, lest they increase. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, CA Cultural Technology Group has 6 warning signs (and 1 that shouldn’t be ignored) we think you should be aware of.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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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 documents. Simply Wall St has no position in any of the stocks mentioned.