Huali Industrial Group (SZSE:300979) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Huali Industrial Group Company Limited (SZSE:300979) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Huali Industrial Group

What Is Huali Industrial Group's Net Debt?

The image below, which you can click on for greater detail, shows that Huali Industrial Group had debt of CN¥528.8m at the end of September 2024, a reduction from CN¥742.9m over a year. But on the other hand it also has CN¥7.73b in cash, leading to a CN¥7.20b 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¥4.80b due within 12 months, and liabilities of CN¥598.3m due beyond 12 months. Offsetting this, it had CN¥7.73b in cash and CN¥3.51b in receivables that were due within 12 months. So it actually has CN¥5.85b 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. 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.

Another good sign is that Huali Industrial Group has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huali Industrial Group has CN¥7.20b in net cash and a decent-looking balance sheet. And we liked the look of last year's 27% year-on-year EBIT growth. So is Huali Industrial Group'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. 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.