These 4 Measures Indicate That Hunan Gold (SZSE:002155) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Hunan Gold Corporation Limited (SZSE:002155) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hunan Gold

What Is Hunan Gold's Net Debt?

As you can see below, Hunan Gold had CN¥76.9m of debt at September 2023, down from CN¥318.5m a year prior. But it also has CN¥609.8m in cash to offset that, meaning it has CN¥532.9m net cash.

How Healthy Is Hunan Gold's Balance Sheet?

The latest balance sheet data shows that Hunan Gold had liabilities of CN¥1.06b due within a year, and liabilities of CN¥203.7m falling due after that. Offsetting this, it had CN¥609.8m in cash and CN¥457.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥196.7m.

This state of affairs indicates that Hunan Gold's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥15.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Hunan Gold boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Hunan Gold grew its EBIT at 16% over the last year, further increasing its ability to manage 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 Hunan Gold'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. Hunan Gold 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. Over the most recent three years, Hunan Gold recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Hunan Gold's liabilities, but we can be reassured by the fact it has has net cash of CN¥532.9m. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in CN¥556m. So is Hunan Gold's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for Hunan Gold 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.