We Think Leader Harmonious Drive Systems (SHSE:688017) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Leader Harmonious Drive Systems Co., Ltd. (SHSE:688017) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Leader Harmonious Drive Systems

How Much Debt Does Leader Harmonious Drive Systems Carry?

The image below, which you can click on for greater detail, shows that Leader Harmonious Drive Systems had debt of CN¥249.9m at the end of September 2024, a reduction from CN¥656.4m over a year. But it also has CN¥608.5m in cash to offset that, meaning it has CN¥358.6m net cash.

How Strong Is Leader Harmonious Drive Systems' Balance Sheet?

We can see from the most recent balance sheet that Leader Harmonious Drive Systems had liabilities of CN¥368.6m falling due within a year, and liabilities of CN¥135.8m due beyond that. Offsetting these obligations, it had cash of CN¥608.5m as well as receivables valued at CN¥174.9m due within 12 months. So it actually has CN¥279.0m more liquid assets than total liabilities.

This state of affairs indicates that Leader Harmonious Drive Systems' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥17.9b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Leader Harmonious Drive Systems has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Leader Harmonious Drive Systems grew its EBIT by 15% last year, making its debt load easier to handle. 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 Leader Harmonious Drive Systems'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. While Leader Harmonious Drive Systems has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Leader Harmonious Drive Systems recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Leader Harmonious Drive Systems has CN¥358.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 15% over the last year. So we are not troubled with Leader Harmonious Drive Systems's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Leader Harmonious Drive Systems (of which 1 is a bit concerning!) you should know about.

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.