Is Guangdong HEC Technology Holding (SHSE:600673) Using Too Much Debt?

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.' 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 Guangdong HEC Technology Holding Co., Ltd (SHSE:600673) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guangdong HEC Technology Holding

What Is Guangdong HEC Technology Holding's Net Debt?

As you can see below, at the end of March 2024, Guangdong HEC Technology Holding had CN¥11.9b of debt, up from CN¥9.42b a year ago. Click the image for more detail. However, it also had CN¥5.73b in cash, and so its net debt is CN¥6.22b.

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¥11.8b falling due within a year, and liabilities of CN¥4.05b due beyond that. Offsetting these obligations, it had cash of CN¥5.73b as well as receivables valued at CN¥3.43b due within 12 months. So its liabilities total CN¥6.74b more than the combination of its cash and short-term receivables.

Guangdong HEC Technology Holding has a market capitalization of CN¥20.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Guangdong HEC Technology Holding shareholders face the double whammy of a high net debt to EBITDA ratio (10.5), and fairly weak interest coverage, since EBIT is just 0.15 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Guangdong HEC Technology Holding saw its EBIT tank 96% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Guangdong HEC Technology Holding'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by 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

To be frank both Guangdong HEC Technology Holding's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. After considering the datapoints discussed, we think Guangdong HEC Technology Holding has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Guangdong HEC Technology Holding (of which 2 make us uncomfortable!) you should know about.

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.

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