Guangdong HEC Technology Holding (SHSE:600673) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Guangdong HEC Technology Holding Co., Ltd (SHSE:600673) does use debt in its business. But the real question is whether this debt is making the company risky.

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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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Guangdong HEC Technology Holding's Debt?

As you can see below, at the end of September 2024, Guangdong HEC Technology Holding had CN¥11.2b of debt, up from CN¥10.6b a year ago. Click the image for more detail. However, it does have CN¥3.91b in cash offsetting this, leading to net debt of about CN¥7.29b.

How Healthy Is Guangdong HEC Technology Holding's Balance Sheet?

We can see from the most recent balance sheet that Guangdong HEC Technology Holding had liabilities of CN¥11.5b falling due within a year, and liabilities of CN¥3.41b due beyond that. Offsetting this, it had CN¥3.91b in cash and CN¥2.98b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.07b.

While this might seem like a lot, it is not so bad since Guangdong HEC Technology Holding has a market capitalization of CN¥29.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

View our latest analysis for Guangdong HEC Technology Holding

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.0 times and a disturbingly high net debt to EBITDA ratio of 7.4 hit our confidence in Guangdong HEC Technology Holding like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The good news is that Guangdong HEC Technology Holding grew its EBIT a smooth 93% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangdong HEC Technology Holding'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Guangdong HEC Technology Holding burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Guangdong HEC Technology Holding's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Guangdong HEC Technology Holding is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Guangdong HEC Technology Holding (of which 2 don't sit too well with us!) you should know about.

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.