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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Huadian Heavy Industries Co., Ltd. (SHSE:601226) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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.

View our latest analysis for Huadian Heavy Industries

How Much Debt Does Huadian Heavy Industries Carry?

You can click the graphic below for the historical numbers, but it shows that Huadian Heavy Industries had CN¥25.0m of debt in June 2024, down from CN¥299.5m, one year before. But it also has CN¥1.16b in cash to offset that, meaning it has CN¥1.14b net cash.

How Strong Is Huadian Heavy Industries' Balance Sheet?

The latest balance sheet data shows that Huadian Heavy Industries had liabilities of CN¥5.61b due within a year, and liabilities of CN¥26.1m falling due after that. On the other hand, it had cash of CN¥1.16b and CN¥5.10b worth of receivables due within a year. So it actually has CN¥629.4m more liquid assets than total liabilities.

This surplus suggests that Huadian Heavy Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Huadian Heavy Industries has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Huadian Heavy Industries if management cannot prevent a repeat of the 72% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Huadian Heavy Industries 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. 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. In the last three years, Huadian Heavy Industries created free cash flow amounting to 2.3% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huadian Heavy Industries has CN¥1.14b in net cash and a decent-looking balance sheet. 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Huadian Heavy Industries .

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.