These 4 Measures Indicate That Kunshan Huguang Auto HarnessLtd (SHSE:605333) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Kunshan Huguang Auto Harness Co.,Ltd. (SHSE:605333) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Kunshan Huguang Auto HarnessLtd

How Much Debt Does Kunshan Huguang Auto HarnessLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Kunshan Huguang Auto HarnessLtd had CN¥2.02b of debt, an increase on CN¥1.83b, over one year. On the flip side, it has CN¥599.6m in cash leading to net debt of about CN¥1.42b.

How Strong Is Kunshan Huguang Auto HarnessLtd's Balance Sheet?

According to the last reported balance sheet, Kunshan Huguang Auto HarnessLtd had liabilities of CN¥4.12b due within 12 months, and liabilities of CN¥826.6m due beyond 12 months. Offsetting these obligations, it had cash of CN¥599.6m as well as receivables valued at CN¥2.97b due within 12 months. So it has liabilities totalling CN¥1.38b more than its cash and near-term receivables, combined.

Since publicly traded Kunshan Huguang Auto HarnessLtd shares are worth a total of CN¥14.0b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

We'd say that Kunshan Huguang Auto HarnessLtd's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its commanding EBIT of 11.2 times its interest expense, implies the debt load is as light as a peacock feather. Even more impressive was the fact that Kunshan Huguang Auto HarnessLtd grew its EBIT by 2,059% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Kunshan Huguang Auto HarnessLtd'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Kunshan Huguang Auto HarnessLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far 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. Considering this range of data points, we think Kunshan Huguang Auto HarnessLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Kunshan Huguang Auto HarnessLtd you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.