Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, New Universe Environmental Group Limited (HKG:436) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for New Universe Environmental Group

What Is New Universe Environmental Group's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2018 New Universe Environmental Group had debt of HK$279.5m, up from HK$207.7m in one year. However, it does have HK$288.4m in cash offsetting this, leading to net cash of HK$8.96m.

How Healthy Is New Universe Environmental Group's Balance Sheet?

The latest balance sheet data shows that New Universe Environmental Group had liabilities of HK$431.5m due within a year, and liabilities of HK$126.0m falling due after that. On the other hand, it had cash of HK$288.4m and HK$47.2m worth of receivables due within a year. So its liabilities total HK$221.8m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because New Universe Environmental Group is worth HK$834.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 6.9% 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 you can't view debt in total isolation; since New Universe Environmental Group will need earnings to service that debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 27% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While New Universe Environmental Group does have more liabilities than liquid assets, it also has net cash of HK$9.0m. So we don't have any problem with New Universe Environmental Group's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in New Universe Environmental Group, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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. Thank you for reading.