These 4 Measures Indicate That Huizhou Desay SV Automotive (SZSE:002920) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Huizhou Desay SV Automotive Co., Ltd. (SZSE:002920) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Huizhou Desay SV Automotive

What Is Huizhou Desay SV Automotive's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Huizhou Desay SV Automotive had CN¥1.15b of debt, an increase on CN¥1.09b, over one year. However, because it has a cash reserve of CN¥628.9m, its net debt is less, at about CN¥524.4m.

How Healthy Is Huizhou Desay SV Automotive's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huizhou Desay SV Automotive had liabilities of CN¥9.44b due within 12 months and liabilities of CN¥807.6m due beyond that. Offsetting this, it had CN¥628.9m in cash and CN¥9.56b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Huizhou Desay SV Automotive's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥58.1b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Huizhou Desay SV Automotive has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Huizhou Desay SV Automotive's net debt is only 0.20 times its EBITDA. And its EBIT easily covers its interest expense, being 101 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Huizhou Desay SV Automotive grew its EBIT by 81% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Huizhou Desay SV Automotive'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Huizhou Desay SV Automotive actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Huizhou Desay SV Automotive's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like Huizhou Desay SV Automotive is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 Huizhou Desay SV Automotive has 2 warning signs (and 1 which is significant) we think you should know about.

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.