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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.' 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 Oriental Education & Technology Group Inc. (NYSE:EDU) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is New Oriental Education & Technology Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of May 2021 New Oriental Education & Technology Group had US$297.6m of debt, an increase on US$117.9m, over one year. However, it does have US$6.26b in cash offsetting this, leading to net cash of US$5.96b.
A Look At New Oriental Education & Technology Group's Liabilities
Zooming in on the latest balance sheet data, we can see that New Oriental Education & Technology Group had liabilities of US$3.47b due within 12 months and liabilities of US$1.66b due beyond that. Offsetting this, it had US$6.26b in cash and US$12.8m in receivables that were due within 12 months. So it actually has US$1.14b more liquid assets than total liabilities.
This luscious liquidity implies that New Oriental Education & Technology Group's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that New Oriental Education & Technology Group has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact New Oriental Education & Technology Group's saving grace is its low debt levels, because its EBIT has tanked 63% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine New Oriental Education & Technology Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. New Oriental Education & Technology 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. Happily for any shareholders, New Oriental Education & Technology Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case New Oriental Education & Technology Group has US$5.96b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$694m, being 202% of its EBIT. So we don't think New Oriental Education & Technology Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for New Oriental Education & Technology Group 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.
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.
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