Is Hangzhou Honghua Digital Technology Stock (SHSE:688789) Using Too Much 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. Importantly, Hangzhou Honghua Digital Technology Stock Company LTD. (SHSE:688789) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hangzhou Honghua Digital Technology Stock

What Is Hangzhou Honghua Digital Technology Stock's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Hangzhou Honghua Digital Technology Stock had debt of CN¥117.7m, up from CN¥10.3m in one year. But on the other hand it also has CN¥1.07b in cash, leading to a CN¥950.3m net cash position.

How Healthy Is Hangzhou Honghua Digital Technology Stock's Balance Sheet?

We can see from the most recent balance sheet that Hangzhou Honghua Digital Technology Stock had liabilities of CN¥546.6m falling due within a year, and liabilities of CN¥63.2m due beyond that. On the other hand, it had cash of CN¥1.07b and CN¥576.4m worth of receivables due within a year. So it can boast CN¥1.03b more liquid assets than total liabilities.

This short term liquidity is a sign that Hangzhou Honghua Digital Technology Stock could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hangzhou Honghua Digital Technology Stock boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Hangzhou Honghua Digital Technology Stock has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hangzhou Honghua Digital Technology Stock'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, a company can only pay off debt with cold hard cash, not accounting profits. While Hangzhou Honghua Digital Technology Stock 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. During the last three years, Hangzhou Honghua Digital Technology Stock 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 we empathize with investors who find debt concerning, you should keep in mind that Hangzhou Honghua Digital Technology Stock has net cash of CN¥950.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 52% over the last year. So we don't have any problem with Hangzhou Honghua Digital Technology Stock's use of debt. 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, we've discovered 1 warning sign for Hangzhou Honghua Digital Technology Stock that you should be aware of before investing here.

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.

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