Huadian Heavy Industries (SHSE:601226) Has A Pretty Healthy Balance Sheet

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 Huadian Heavy Industries Co., Ltd. (SHSE:601226) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Huadian Heavy Industries

What Is Huadian Heavy Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Huadian Heavy Industries had CN¥25.0m of debt in March 2024, down from CN¥299.5m, one year before. However, its balance sheet shows it holds CN¥1.39b in cash, so it actually has CN¥1.37b net cash.

How Strong Is Huadian Heavy Industries' Balance Sheet?

According to the last reported balance sheet, Huadian Heavy Industries had liabilities of CN¥6.06b due within 12 months, and liabilities of CN¥35.1m due beyond 12 months. Offsetting this, it had CN¥1.39b in cash and CN¥4.44b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥257.3m.

Of course, Huadian Heavy Industries has a market capitalization of CN¥6.38b, 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. Despite its noteworthy liabilities, Huadian Heavy Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Huadian Heavy Industries's saving grace is its low debt levels, because its EBIT has tanked 74% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Huadian Heavy Industries's ability to maintain a healthy balance sheet going forward. 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. Huadian Heavy Industries 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, Huadian Heavy Industries recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Huadian Heavy Industries's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.37b. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in CN¥27m. So we don't have any problem with Huadian Heavy Industries's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Huadian Heavy Industries , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.