Here's Why HUANLEJIA Food GroupLtd (SZSE:300997) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that HUANLEJIA Food Group CO.,Ltd (SZSE:300997) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 HUANLEJIA Food GroupLtd

What Is HUANLEJIA Food GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 HUANLEJIA Food GroupLtd had debt of CN¥261.5m, up from none in one year. But it also has CN¥467.5m in cash to offset that, meaning it has CN¥206.0m net cash.

How Strong Is HUANLEJIA Food GroupLtd's Balance Sheet?

The latest balance sheet data shows that HUANLEJIA Food GroupLtd had liabilities of CN¥788.4m due within a year, and liabilities of CN¥33.0m falling due after that. Offsetting these obligations, it had cash of CN¥467.5m as well as receivables valued at CN¥148.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥205.7m.

Given HUANLEJIA Food GroupLtd has a market capitalization of CN¥4.62b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, HUANLEJIA Food GroupLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, HUANLEJIA Food GroupLtd saw its EBIT drop by 8.7% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HUANLEJIA Food GroupLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. HUANLEJIA Food GroupLtd 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. In the last three years, HUANLEJIA Food GroupLtd's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that HUANLEJIA Food GroupLtd has CN¥206.0m in net cash. So we are not troubled with HUANLEJIA Food GroupLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with HUANLEJIA Food GroupLtd (at least 1 which is significant) , 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.