Is Hubei DinglongLtd (SZSE:300054) 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.' 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 note that Hubei Dinglong CO.,Ltd. (SZSE:300054) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hubei DinglongLtd

What Is Hubei DinglongLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Hubei DinglongLtd had debt of CN¥897.8m, up from CN¥143.3m in one year. However, it does have CN¥1.32b in cash offsetting this, leading to net cash of CN¥420.4m.

How Healthy Is Hubei DinglongLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hubei DinglongLtd had liabilities of CN¥835.0m due within 12 months and liabilities of CN¥861.0m due beyond that. On the other hand, it had cash of CN¥1.32b and CN¥927.4m worth of receivables due within a year. So it can boast CN¥549.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Hubei DinglongLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hubei DinglongLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Hubei DinglongLtd's load is not too heavy, because its EBIT was down 43% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hubei DinglongLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hubei DinglongLtd 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. During the last three years, Hubei DinglongLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hubei DinglongLtd has net cash of CN¥420.4m, as well as more liquid assets than liabilities. So while Hubei DinglongLtd does not have a great balance sheet, it's certainly not too bad. 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. Case in point: We've spotted 1 warning sign for Hubei DinglongLtd you should be aware of.

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.