Is Suzhou Hesheng Special Material (SZSE:002290) Using Too Much Debt?

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 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. Importantly, Suzhou Hesheng Special Material Co., Ltd. (SZSE:002290) does carry debt. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Suzhou Hesheng Special Material

What Is Suzhou Hesheng Special Material's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Suzhou Hesheng Special Material had CN¥168.4m of debt in September 2024, down from CN¥285.2m, one year before. However, it does have CN¥372.3m in cash offsetting this, leading to net cash of CN¥203.9m.

A Look At Suzhou Hesheng Special Material's Liabilities

Zooming in on the latest balance sheet data, we can see that Suzhou Hesheng Special Material had liabilities of CN¥808.2m due within 12 months and liabilities of CN¥152.5m due beyond that. On the other hand, it had cash of CN¥372.3m and CN¥534.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥53.6m.

Having regard to Suzhou Hesheng Special Material's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥4.48b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Suzhou Hesheng Special Material boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Suzhou Hesheng Special Material has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Suzhou Hesheng Special Material will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Suzhou Hesheng Special Material 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. Happily for any shareholders, Suzhou Hesheng Special Material actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Suzhou Hesheng Special Material's liabilities, but we can be reassured by the fact it has has net cash of CN¥203.9m. The cherry on top was that in converted 169% of that EBIT to free cash flow, bringing in CN¥238m. So we don't think Suzhou Hesheng Special Material's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Suzhou Hesheng Special Material, you may well want to click here to check an interactive graph of its earnings per share history.

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.