We Think Puyang Huicheng Electronic Material (SZSE:300481) Can Stay On Top Of Its 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 can see that Puyang Huicheng Electronic Material Co., Ltd. (SZSE:300481) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Puyang Huicheng Electronic Material

What Is Puyang Huicheng Electronic Material's Debt?

You can click the graphic below for the historical numbers, but it shows that Puyang Huicheng Electronic Material had CN¥255.6m of debt in March 2024, down from CN¥399.2m, one year before. But on the other hand it also has CN¥924.2m in cash, leading to a CN¥668.6m net cash position.

How Strong Is Puyang Huicheng Electronic Material's Balance Sheet?

According to the last reported balance sheet, Puyang Huicheng Electronic Material had liabilities of CN¥216.3m due within 12 months, and liabilities of CN¥172.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥924.2m as well as receivables valued at CN¥437.7m due within 12 months. So it can boast CN¥973.1m more liquid assets than total liabilities.

It's good to see that Puyang Huicheng Electronic Material has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Puyang Huicheng Electronic Material boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Puyang Huicheng Electronic Material's load is not too heavy, because its EBIT was down 53% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Puyang Huicheng Electronic Material'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. While Puyang Huicheng Electronic 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. Looking at the most recent three years, Puyang Huicheng Electronic Material recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Puyang Huicheng Electronic Material has net cash of CN¥668.6m, as well as more liquid assets than liabilities. So we don't have any problem with Puyang Huicheng Electronic Material's use of debt. 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. To that end, you should be aware of the 3 warning signs we've spotted with Puyang Huicheng Electronic Material .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

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