Huabao Flavours & Fragrances (SZSE:300741) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Huabao Flavours & Fragrances Co., Ltd. (SZSE:300741) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Huabao Flavours & Fragrances

How Much Debt Does Huabao Flavours & Fragrances Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Huabao Flavours & Fragrances had CN¥274.0m of debt, an increase on CN¥195.8m, over one year. But on the other hand it also has CN¥4.85b in cash, leading to a CN¥4.58b net cash position.

How Strong Is Huabao Flavours & Fragrances' Balance Sheet?

The latest balance sheet data shows that Huabao Flavours & Fragrances had liabilities of CN¥540.7m due within a year, and liabilities of CN¥209.6m falling due after that. Offsetting these obligations, it had cash of CN¥4.85b as well as receivables valued at CN¥498.4m due within 12 months. So it actually has CN¥4.60b more liquid assets than total liabilities.

This surplus strongly suggests that Huabao Flavours & Fragrances has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Huabao Flavours & Fragrances has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Huabao Flavours & Fragrances's saving grace is its low debt levels, because its EBIT has tanked 52% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Huabao Flavours & Fragrances will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Huabao Flavours & Fragrances 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. Happily for any shareholders, Huabao Flavours & Fragrances 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

While it is always sensible to investigate a company's debt, in this case Huabao Flavours & Fragrances has CN¥4.58b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 120% of that EBIT to free cash flow, bringing in CN¥425m. So is Huabao Flavours & Fragrances's debt a risk? It doesn't seem so to us. 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. For example Huabao Flavours & Fragrances has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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.

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