Is Shenzhen Hopewind Electric (SHSE:603063) Using Too Much Debt?

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.' 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 Shenzhen Hopewind Electric Co., Ltd. (SHSE:603063) makes use of 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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shenzhen Hopewind Electric

What Is Shenzhen Hopewind Electric's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Shenzhen Hopewind Electric had debt of CN¥645.4m, up from CN¥486.6m in one year. But on the other hand it also has CN¥909.7m in cash, leading to a CN¥264.3m net cash position.

How Healthy Is Shenzhen Hopewind Electric's Balance Sheet?

The latest balance sheet data shows that Shenzhen Hopewind Electric had liabilities of CN¥2.11b due within a year, and liabilities of CN¥628.6m falling due after that. On the other hand, it had cash of CN¥909.7m and CN¥2.50b worth of receivables due within a year. So it actually has CN¥671.5m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Hopewind Electric has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen Hopewind Electric boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Shenzhen Hopewind Electric grew its EBIT by 136% 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 Shenzhen Hopewind Electric'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. Shenzhen Hopewind Electric 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. During the last three years, Shenzhen Hopewind Electric burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Hopewind Electric has CN¥264.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 136% over the last year. So we are not troubled with Shenzhen Hopewind Electric's debt use. 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. We've identified 1 warning sign with Shenzhen Hopewind Electric , and understanding them should be part of your investment process.

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.