Is China Maple Leaf Educational Systems (HKG:1317) A Risky Investment?

Simply Wall St

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China Maple Leaf Educational Systems Limited (HKG:1317) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Maple Leaf Educational Systems

What Is China Maple Leaf Educational Systems's Debt?

As you can see below, China Maple Leaf Educational Systems had CN¥331.0m of debt at August 2019, down from CN¥431.3m a year prior. But it also has CN¥2.84b in cash to offset that, meaning it has CN¥2.51b net cash.

SEHK:1317 Historical Debt March 29th 2020

How Strong Is China Maple Leaf Educational Systems's Balance Sheet?

The latest balance sheet data shows that China Maple Leaf Educational Systems had liabilities of CN¥2.02b due within a year, and liabilities of CN¥259.0m falling due after that. Offsetting these obligations, it had cash of CN¥2.84b as well as receivables valued at CN¥118.9m due within 12 months. So it can boast CN¥685.2m more liquid assets than total liabilities.

This short term liquidity is a sign that China Maple Leaf Educational Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Maple Leaf Educational Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that China Maple Leaf Educational Systems grew its EBIT by 17% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Maple Leaf Educational Systems can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Maple Leaf Educational Systems 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. Over the last three years, China Maple Leaf Educational Systems actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Maple Leaf Educational Systems has net cash of CN¥2.51b, as well as more liquid assets than liabilities. The cherry on top was that in converted 134% of that EBIT to free cash flow, bringing in CN¥720m. So we don't think China Maple Leaf Educational Systems's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that China Maple Leaf Educational Systems is showing 3 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.