Is Huangshan NovelLtd (SZSE:002014) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Huangshan Novel Co.,Ltd (SZSE:002014) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Huangshan NovelLtd

What Is Huangshan NovelLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Huangshan NovelLtd had debt of CN¥712.1m, up from CN¥516.4m in one year. However, it does have CN¥1.48b in cash offsetting this, leading to net cash of CN¥767.8m.

How Strong Is Huangshan NovelLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huangshan NovelLtd had liabilities of CN¥1.24b due within 12 months and liabilities of CN¥154.4m due beyond that. On the other hand, it had cash of CN¥1.48b and CN¥699.7m worth of receivables due within a year. So it can boast CN¥780.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Huangshan NovelLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Huangshan NovelLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Huangshan NovelLtd has been able to increase its EBIT by 22% 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 ultimately the future profitability of the business will decide if Huangshan NovelLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Huangshan NovelLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Huangshan NovelLtd produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huangshan NovelLtd has CN¥767.8m in net cash and a decent-looking balance sheet. And we liked the look of last year's 22% year-on-year EBIT growth. So we don't think Huangshan NovelLtd's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Huangshan NovelLtd's dividend history, without delay!

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.