These 4 Measures Indicate That Hangzhou Greatstar Industrial (SZSE:002444) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Hangzhou Greatstar Industrial Co., Ltd (SZSE:002444) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hangzhou Greatstar Industrial

What Is Hangzhou Greatstar Industrial's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hangzhou Greatstar Industrial had CN¥3.42b of debt in September 2023, down from CN¥3.96b, one year before. However, it does have CN¥6.53b in cash offsetting this, leading to net cash of CN¥3.11b.

How Strong Is Hangzhou Greatstar Industrial's Balance Sheet?

According to the last reported balance sheet, Hangzhou Greatstar Industrial had liabilities of CN¥5.63b due within 12 months, and liabilities of CN¥569.4m due beyond 12 months. On the other hand, it had cash of CN¥6.53b and CN¥2.60b worth of receivables due within a year. So it can boast CN¥2.93b more liquid assets than total liabilities.

This surplus suggests that Hangzhou Greatstar Industrial has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Hangzhou Greatstar Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Hangzhou Greatstar Industrial grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hangzhou Greatstar Industrial'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hangzhou Greatstar Industrial 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. Looking at the most recent three years, Hangzhou Greatstar Industrial recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hangzhou Greatstar Industrial has net cash of CN¥3.11b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 23% over the last year. So is Hangzhou Greatstar Industrial's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Hangzhou Greatstar Industrial , and understanding them should be part of your investment process.

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.