Is Jiangsu Hengli HydraulicLtd (SHSE:601100) 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. We can see that Jiangsu Hengli Hydraulic Co.,Ltd (SHSE:601100) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Jiangsu Hengli HydraulicLtd

What Is Jiangsu Hengli HydraulicLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Jiangsu Hengli HydraulicLtd had debt of CN¥199.6m at the end of March 2024, a reduction from CN¥305.1m over a year. However, its balance sheet shows it holds CN¥7.81b in cash, so it actually has CN¥7.61b net cash.

How Strong Is Jiangsu Hengli HydraulicLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Hengli HydraulicLtd had liabilities of CN¥3.17b due within 12 months, and liabilities of CN¥346.8m due beyond 12 months. On the other hand, it had cash of CN¥7.81b and CN¥3.29b worth of receivables due within a year. So it actually has CN¥7.59b more liquid assets than total liabilities.

This short term liquidity is a sign that Jiangsu Hengli HydraulicLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Jiangsu Hengli HydraulicLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Jiangsu Hengli HydraulicLtd has increased its EBIT by 4.0% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangsu Hengli HydraulicLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Jiangsu Hengli HydraulicLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Jiangsu Hengli HydraulicLtd recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangsu Hengli HydraulicLtd has CN¥7.61b in net cash and a decent-looking balance sheet. So is Jiangsu Hengli HydraulicLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Jiangsu Hengli HydraulicLtd has 2 warning signs (and 1 which is concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com