Haohua Chemical Science & Technology (SHSE:600378) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Haohua Chemical Science & Technology Corp., Ltd. (SHSE:600378) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Haohua Chemical Science & Technology

What Is Haohua Chemical Science & Technology's Debt?

As you can see below, at the end of March 2024, Haohua Chemical Science & Technology had CN¥2.77b of debt, up from CN¥2.08b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥2.13b, its net debt is less, at about CN¥641.8m.

How Strong Is Haohua Chemical Science & Technology's Balance Sheet?

We can see from the most recent balance sheet that Haohua Chemical Science & Technology had liabilities of CN¥3.92b falling due within a year, and liabilities of CN¥3.04b due beyond that. On the other hand, it had cash of CN¥2.13b and CN¥3.59b worth of receivables due within a year. So its liabilities total CN¥1.24b more than the combination of its cash and short-term receivables.

Given Haohua Chemical Science & Technology has a market capitalization of CN¥27.2b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Haohua Chemical Science & Technology has a low debt to EBITDA ratio of only 0.51. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. In fact Haohua Chemical Science & Technology's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Haohua Chemical Science & Technology'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Haohua Chemical Science & Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Haohua Chemical Science & Technology's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Haohua Chemical Science & Technology is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Haohua Chemical Science & Technology , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.