Hebei Huatong Wires and Cables Group (SHSE:605196) Seems To Use Debt Quite Sensibly

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 Hebei Huatong Wires and Cables Group Co., Ltd. (SHSE:605196) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hebei Huatong Wires and Cables Group

How Much Debt Does Hebei Huatong Wires and Cables Group Carry?

The image below, which you can click on for greater detail, shows that Hebei Huatong Wires and Cables Group had debt of CN¥1.88b at the end of June 2024, a reduction from CN¥2.48b over a year. On the flip side, it has CN¥791.9m in cash leading to net debt of about CN¥1.09b.

How Strong Is Hebei Huatong Wires and Cables Group's Balance Sheet?

The latest balance sheet data shows that Hebei Huatong Wires and Cables Group had liabilities of CN¥2.60b due within a year, and liabilities of CN¥237.8m falling due after that. On the other hand, it had cash of CN¥791.9m and CN¥1.93b worth of receivables due within a year. So its liabilities total CN¥117.3m more than the combination of its cash and short-term receivables.

Of course, Hebei Huatong Wires and Cables Group has a market capitalization of CN¥4.19b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Hebei Huatong Wires and Cables Group's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its strong interest cover of 13.8 times, makes us even more comfortable. One way Hebei Huatong Wires and Cables Group could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 12%, as it did over the last year. 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 Hebei Huatong Wires and Cables Group can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Hebei Huatong Wires and Cables Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Hebei Huatong Wires and Cables Group's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Hebei Huatong Wires and Cables Group is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Hebei Huatong Wires and Cables Group has 1 warning sign we think you should be aware of.

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.