Is HUAYU Automotive Systems (SHSE:600741) A Risky Investment?

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. Importantly, HUAYU Automotive Systems Company Limited (SHSE:600741) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for HUAYU Automotive Systems

What Is HUAYU Automotive Systems's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 HUAYU Automotive Systems had debt of CN¥16.7b, up from CN¥14.5b in one year. But on the other hand it also has CN¥41.5b in cash, leading to a CN¥24.7b net cash position.

A Look At HUAYU Automotive Systems' Liabilities

According to the last reported balance sheet, HUAYU Automotive Systems had liabilities of CN¥101.6b due within 12 months, and liabilities of CN¥9.98b due beyond 12 months. On the other hand, it had cash of CN¥41.5b and CN¥48.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥21.3b.

This deficit isn't so bad because HUAYU Automotive Systems is worth CN¥48.3b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, HUAYU Automotive Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, HUAYU Automotive Systems grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if HUAYU Automotive Systems can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While HUAYU Automotive Systems 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. During the last three years, HUAYU Automotive Systems generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although HUAYU Automotive Systems's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥24.7b. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in CN¥7.1b. So we are not troubled with HUAYU Automotive Systems's debt use. 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. For example, we've discovered 1 warning sign for HUAYU Automotive Systems that you should be aware of before investing here.

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.

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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.

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