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. As with many other companies Meitu, Inc. (HKG:1357) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Meitu

How Much Debt Does Meitu Carry?

As you can see below, Meitu had CN¥10.0m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥2.46b in cash, so it actually has CN¥2.45b net cash.

How Healthy Is Meitu's Balance Sheet?

We can see from the most recent balance sheet that Meitu had liabilities of CN¥709.4m falling due within a year, and liabilities of CN¥117.9m due beyond that. On the other hand, it had cash of CN¥2.46b and CN¥764.0m worth of receivables due within a year. So it can boast CN¥2.40b more liquid assets than total liabilities.

This surplus liquidity suggests that Meitu's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Meitu has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Meitu's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Meitu saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

So How Risky Is Meitu?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Meitu had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of CN¥1.3b and booked a CN¥1.1b accounting loss. But at least it has CN¥2.45b on the balance sheet to spend on growth, near-term. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. For riskier companies like Meitu I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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