New Universe Environmental Group (HKG:436) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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 New Universe Environmental Group Limited (HKG:436) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses 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 and debt together.

See our latest analysis for New Universe Environmental Group

What Is New Universe Environmental Group's Debt?

You can click the graphic below for the historical numbers, but it shows that New Universe Environmental Group had HK$265.4m of debt in December 2019, down from HK$279.5m, one year before. But it also has HK$267.4m in cash to offset that, meaning it has HK$1.98m net cash.

A Look At New Universe Environmental Group's Liabilities

Zooming in on the latest balance sheet data, we can see that New Universe Environmental Group had liabilities of HK$459.8m due within 12 months and liabilities of HK$130.5m due beyond that. Offsetting these obligations, it had cash of HK$267.4m as well as receivables valued at HK$89.9m due within 12 months. So it has liabilities totalling HK$232.9m more than its cash and near-term receivables, combined.

New Universe Environmental Group has a market capitalization of HK$592.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, New Universe Environmental Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, New Universe Environmental Group saw its EBIT drop by 7.4% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is New Universe Environmental Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. New Universe Environmental Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, New Universe Environmental Group's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although New Universe Environmental Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$1.98m. So we don't have any problem with New Universe Environmental Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - New Universe Environmental Group has 5 warning signs (and 1 which is potentially serious) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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