We Think Dalian Huarui Heavy Industry Group (SZSE:002204) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Dalian Huarui Heavy Industry Group Co., LTD. (SZSE:002204) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Dalian Huarui Heavy Industry Group

How Much Debt Does Dalian Huarui Heavy Industry Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Dalian Huarui Heavy Industry Group had CN¥1.64b of debt, an increase on CN¥898.2m, over one year. But it also has CN¥3.39b in cash to offset that, meaning it has CN¥1.75b net cash.

A Look At Dalian Huarui Heavy Industry Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Dalian Huarui Heavy Industry Group had liabilities of CN¥15.0b due within 12 months and liabilities of CN¥2.24b due beyond that. Offsetting this, it had CN¥3.39b in cash and CN¥8.16b in receivables that were due within 12 months. So its liabilities total CN¥5.72b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥8.81b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Dalian Huarui Heavy Industry Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Dalian Huarui Heavy Industry Group grew its EBIT by 124% last year, which is an impressive improvement. 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 ultimately the future profitability of the business will decide if Dalian Huarui Heavy Industry Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Dalian Huarui Heavy Industry Group 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, Dalian Huarui Heavy Industry Group saw substantial negative free cash flow, in total. 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

Although Dalian Huarui Heavy Industry Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.75b. And it impressed us with its EBIT growth of 124% over the last year. So we are not troubled with Dalian Huarui Heavy Industry Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Dalian Huarui Heavy Industry Group , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.