These 4 Measures Indicate That Hebei Huatong Wires and Cables Group (SHSE:605196) Is Using Debt Extensively

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Hebei Huatong Wires and Cables Group Co., Ltd. (SHSE:605196) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hebei Huatong Wires and Cables Group

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

As you can see below, at the end of September 2024, Hebei Huatong Wires and Cables Group had CN¥2.51b of debt, up from CN¥2.13b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.08b, its net debt is less, at about CN¥1.43b.

A Look At Hebei Huatong Wires and Cables Group's Liabilities

We can see from the most recent balance sheet that Hebei Huatong Wires and Cables Group had liabilities of CN¥2.69b falling due within a year, and liabilities of CN¥811.0m due beyond that. Offsetting this, it had CN¥1.08b in cash and CN¥1.97b in receivables that were due within 12 months. So its liabilities total CN¥456.0m 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¥5.70b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Hebei Huatong Wires and Cables Group's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its commanding EBIT of 11.9 times its interest expense, implies the debt load is as light as a peacock feather. Notably Hebei Huatong Wires and Cables Group's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hebei Huatong Wires and Cables Group'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Hebei Huatong Wires and Cables Group 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.

Our View

Hebei Huatong Wires and Cables Group's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its interest cover was re-invigorating. Looking at all the angles mentioned above, it does seem to us that Hebei Huatong Wires and Cables Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Case in point: We've spotted 3 warning signs for Hebei Huatong Wires and Cables Group you should be aware of, and 2 of them make us uncomfortable.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.