Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies MTT Group Holdings Limited (HKG:2350) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for MTT Group Holdings
What Is MTT Group Holdings's Debt?
The chart below, which you can click on for greater detail, shows that MTT Group Holdings had HK$59.9m in debt in March 2024; about the same as the year before. However, it also had HK$10.7m in cash, and so its net debt is HK$49.2m.
How Strong Is MTT Group Holdings' Balance Sheet?
According to the last reported balance sheet, MTT Group Holdings had liabilities of HK$280.4m due within 12 months, and liabilities of HK$6.46m due beyond 12 months. On the other hand, it had cash of HK$10.7m and HK$375.0m worth of receivables due within a year. So it actually has HK$98.8m more liquid assets than total liabilities.
This surplus suggests that MTT Group Holdings is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since MTT Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year MTT Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 17%, to HK$628m. We would much prefer see growth.
Caveat Emptor
While MTT Group Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at HK$14m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with MTT Group Holdings (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.