Is Hwa Create (SZSE:300045) A Risky Investment?

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.' 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. We can see that Hwa Create Corporation (SZSE:300045) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Hwa Create

What Is Hwa Create's Net Debt?

The image below, which you can click on for greater detail, shows that Hwa Create had debt of CN¥40.2m at the end of June 2024, a reduction from CN¥58.8m over a year. However, it does have CN¥285.5m in cash offsetting this, leading to net cash of CN¥245.2m.

A Look At Hwa Create's Liabilities

We can see from the most recent balance sheet that Hwa Create had liabilities of CN¥599.0m falling due within a year, and liabilities of CN¥114.6m due beyond that. Offsetting these obligations, it had cash of CN¥285.5m as well as receivables valued at CN¥610.1m due within 12 months. So it actually has CN¥182.0m more liquid assets than total liabilities.

This state of affairs indicates that Hwa Create's 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¥18.6b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Hwa Create has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Hwa Create turned things around in the last 12 months, delivering and EBIT of CN¥27m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hwa Create 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. Hwa Create may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Hwa Create actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hwa Create has CN¥245.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥111m, being 410% of its EBIT. So we don't think Hwa Create's use of debt is risky. 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. Be aware that Hwa Create is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.