Legendary fund manager Li Lu (who 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. 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, Virscend Education Company Limited (HKG: 1565) carries a debt. But does this debt worry shareholders?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. 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. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Virscend Education
What is the debt of Virscend Education?
You can click on the graph below for historical figures, but it shows that as of June 2021, Virscend Education had debt of CN 3.68 billion, an increase from CN 2.64 billion, on a year. However, given that it has a cash reserve of CNN 547.8 million, its net debt is less, at around CN3 3.13 billion.
How strong is Virscend Education’s balance sheet?
The latest balance sheet data shows Virscend Education had CN 2.90 billion in liabilities maturing within one year, and CN 1.95 billion in liabilities maturing after that. On the other hand, he had a cash position of CN 547.8 million and CN 1.68 million of receivables due within one year. It therefore has liabilities totaling 4.30 billion yen more than its combined cash and short-term receivables.
This deficit casts a shadow over the CN ¥ 1.05b company, like a colossus towering over mere mortals. We therefore believe that shareholders should watch it closely. Ultimately, Virscend Education would likely need a major recapitalization if its creditors demanded repayment.
We measure a company’s debt load relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest 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).
While we’re not worried about Virscend Education’s net debt to EBITDA ratio of 5.0, we do think its ultra-low 2.3x interest coverage is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Another concern for investors could be that Virscend Education’s EBIT fell 12% last year. If this is the way things continue, managing the debt burden will be like delivering hot coffees on a pogo stick. 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 Virscend Education will need income to repay this debt. So if you want to know more about its profits, it may be worth checking out this long term profit trend chart.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Virscend Education has recorded substantial total negative free cash flow. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
To be frank, Virscend Education’s conversion of EBIT to free cash flow and its track record of controlling its total liabilities makes us rather uncomfortable with its debt levels. And even his net debt to EBITDA doesn’t inspire much confidence. We believe that the chances that Virscend Education has too much debt are very high. In our opinion, this means that the stock is rather risky, and probably to be avoided; but to each their own (investment) style. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Be aware that Virscend Education shows 5 warning signs in our investment analysis , and 1 of them concerns …
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page. 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 documents. Simply Wall St has no position in any of the stocks mentioned.
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