Is Kunshan Huguang Auto HarnessLtd (SHSE:605333) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Kunshan Huguang Auto Harness Co.,Ltd. (SHSE:605333) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kunshan Huguang Auto HarnessLtd

What Is Kunshan Huguang Auto HarnessLtd's Debt?

As you can see below, at the end of June 2024, Kunshan Huguang Auto HarnessLtd had CN¥2.04b of debt, up from CN¥1.67b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥574.0m, its net debt is less, at about CN¥1.47b.

A Look At Kunshan Huguang Auto HarnessLtd's Liabilities

We can see from the most recent balance sheet that Kunshan Huguang Auto HarnessLtd had liabilities of CN¥3.93b falling due within a year, and liabilities of CN¥738.8m due beyond that. Offsetting this, it had CN¥574.0m in cash and CN¥2.54b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.55b more than its cash and near-term receivables, combined.

Of course, Kunshan Huguang Auto HarnessLtd has a market capitalization of CN¥11.1b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kunshan Huguang Auto HarnessLtd's net debt of 2.4 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.6 times interest expense) certainly does not do anything to dispel this impression. Pleasingly, Kunshan Huguang Auto HarnessLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 1,480% gain in the last twelve months. 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 Kunshan Huguang Auto HarnessLtd 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. So we always check how much of that EBIT is translated into free cash flow. During the last two years, Kunshan Huguang Auto HarnessLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Kunshan Huguang Auto HarnessLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Kunshan Huguang Auto HarnessLtd's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Kunshan Huguang Auto HarnessLtd , and understanding them should be part of your investment process.

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.