Hualan Biological Engineering (SZSE:002007) Seems To Use Debt Quite Sensibly

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, Hualan Biological Engineering Inc. (SZSE:002007) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hualan Biological Engineering

What Is Hualan Biological Engineering's Debt?

The image below, which you can click on for greater detail, shows that Hualan Biological Engineering had debt of CN¥750.8m at the end of September 2024, a reduction from CN¥900.0m over a year. But it also has CN¥2.62b in cash to offset that, meaning it has CN¥1.87b net cash.

How Strong Is Hualan Biological Engineering's Balance Sheet?

The latest balance sheet data shows that Hualan Biological Engineering had liabilities of CN¥2.29b due within a year, and liabilities of CN¥99.9m falling due after that. On the other hand, it had cash of CN¥2.62b and CN¥2.53b worth of receivables due within a year. So it actually has CN¥2.76b more liquid assets than total liabilities.

This surplus suggests that Hualan Biological Engineering has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Hualan Biological Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

While Hualan Biological Engineering doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hualan Biological Engineering's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hualan Biological Engineering 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. In the last three years, Hualan Biological Engineering's free cash flow amounted to 31% of its EBIT, less 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 Hualan Biological Engineering has net cash of CN¥1.87b, as well as more liquid assets than liabilities. So we are not troubled with Hualan Biological Engineering's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hualan Biological Engineering has 1 warning sign we think 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.

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.