We Think Dalian Huarui Heavy Industry Group (SZSE:002204) 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 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. As with many other companies Dalian Huarui Heavy Industry Group Co., LTD. (SZSE:002204) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Dalian Huarui Heavy Industry Group

What Is Dalian Huarui Heavy Industry Group's Debt?

As you can see below, Dalian Huarui Heavy Industry Group had CN¥1.50b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥3.18b in cash, leading to a CN¥1.68b net cash position.

How Healthy Is Dalian Huarui Heavy Industry Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dalian Huarui Heavy Industry Group had liabilities of CN¥16.2b due within 12 months and liabilities of CN¥1.92b due beyond that. Offsetting this, it had CN¥3.18b in cash and CN¥8.67b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.28b.

This is a mountain of leverage relative to its market capitalization of CN¥9.62b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Dalian Huarui Heavy Industry Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Dalian Huarui Heavy Industry Group grew its EBIT by 19% last year, making its debt load easier to handle. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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¥1.68b. And we liked the look of last year's 19% year-on-year EBIT growth. So we are not troubled with Dalian Huarui Heavy Industry Group's debt use. 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. For example - Dalian Huarui Heavy Industry Group has 1 warning sign we think you should be aware of.

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.