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These 4 Measures Indicate That Momo (NASDAQ:MOMO) Is Using Debt Safely

Simply Wall St
·4-min read

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. As with many other companies Momo Inc. (NASDAQ:MOMO) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Momo

What Is Momo's Net Debt?

The chart below, which you can click on for greater detail, shows that Momo had CN¥5.04b in debt in June 2020; about the same as the year before. But it also has CN¥12.3b in cash to offset that, meaning it has CN¥7.24b net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Momo's Balance Sheet?

The latest balance sheet data shows that Momo had liabilities of CN¥2.38b due within a year, and liabilities of CN¥6.23b falling due after that. On the other hand, it had cash of CN¥12.3b and CN¥256.7m worth of receivables due within a year. So it actually has CN¥3.92b more liquid assets than total liabilities.

This surplus suggests that Momo 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. Succinctly put, Momo boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Momo has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Momo can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Momo has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Momo 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Momo has net cash of CN¥7.24b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥4.0b, being 115% of its EBIT. When it comes to Momo's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Momo you should know about.

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.

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.