Huada Automotive TechnologyLtd (SHSE:603358) Has A Pretty Healthy Balance Sheet

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.' 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 Huada Automotive Technology Corp.,Ltd (SHSE:603358) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Huada Automotive TechnologyLtd

What Is Huada Automotive TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Huada Automotive TechnologyLtd had debt of CN¥647.6m, up from CN¥436.2m in one year. However, its balance sheet shows it holds CN¥745.8m in cash, so it actually has CN¥98.1m net cash.

How Strong Is Huada Automotive TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huada Automotive TechnologyLtd had liabilities of CN¥2.23b due within 12 months and liabilities of CN¥427.5m due beyond that. On the other hand, it had cash of CN¥745.8m and CN¥1.11b worth of receivables due within a year. So its liabilities total CN¥806.6m more than the combination of its cash and short-term receivables.

Since publicly traded Huada Automotive TechnologyLtd shares are worth a total of CN¥14.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Huada Automotive TechnologyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Huada Automotive TechnologyLtd grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Huada Automotive TechnologyLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Huada Automotive TechnologyLtd 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. In the last three years, Huada Automotive TechnologyLtd created free cash flow amounting to 7.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Huada Automotive TechnologyLtd has CN¥98.1m in net cash. And it impressed us with its EBIT growth of 17% over the last year. So we don't have any problem with Huada Automotive TechnologyLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Huada Automotive TechnologyLtd .

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.