Does Huali Industrial Group (SZSE:300979) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Huali Industrial Group Company Limited (SZSE:300979) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huali Industrial Group

What Is Huali Industrial Group's Debt?

As you can see below, Huali Industrial Group had CN¥316.7m of debt at June 2024, down from CN¥1.31b a year prior. However, its balance sheet shows it holds CN¥6.63b in cash, so it actually has CN¥6.31b net cash.

How Healthy Is Huali Industrial Group's Balance Sheet?

The latest balance sheet data shows that Huali Industrial Group had liabilities of CN¥5.38b due within a year, and liabilities of CN¥373.7m falling due after that. Offsetting this, it had CN¥6.63b in cash and CN¥4.50b in receivables that were due within 12 months. So it can boast CN¥5.38b more liquid assets than total liabilities.

This surplus suggests that Huali Industrial Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Huali Industrial Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Huali Industrial Group grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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 Huali Industrial 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. Huali Industrial Group 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. Over the most recent three years, Huali Industrial Group recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huali Industrial Group has CN¥6.31b in net cash and a decent-looking balance sheet. And we liked the look of last year's 22% year-on-year EBIT growth. So we don't think Huali Industrial Group'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. Case in point: We've spotted 1 warning sign for Huali Industrial Group you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.