Huali Industrial Group (SZSE:300979) Seems To Use Debt Quite Sensibly

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 Huali Industrial Group Company Limited (SZSE:300979) makes use of 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Huali Industrial Group

How Much Debt Does Huali Industrial Group Carry?

You can click the graphic below for the historical numbers, but it shows that Huali Industrial Group had CN¥742.9m of debt in September 2023, down from CN¥2.23b, one year before. But on the other hand it also has CN¥6.28b in cash, leading to a CN¥5.54b net cash position.

How Strong Is Huali Industrial Group's Balance Sheet?

According to the last reported balance sheet, Huali Industrial Group had liabilities of CN¥4.27b due within 12 months, and liabilities of CN¥235.2m due beyond 12 months. On the other hand, it had cash of CN¥6.28b and CN¥2.92b worth of receivables due within a year. So it can boast CN¥4.70b more liquid assets than total liabilities.

This short term liquidity is a sign that Huali Industrial Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Huali Industrial Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Huali Industrial Group saw its EBIT drop by 5.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Huali Industrial Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Huali Industrial 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. During the last three years, Huali Industrial Group produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huali Industrial Group has net cash of CN¥5.54b, as well as more liquid assets than liabilities. So we are not troubled with Huali Industrial 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. Be aware that Huali Industrial Group is showing 1 warning sign in our investment analysis , you should know about...

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.

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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.