Is Hangzhou First Applied Material (SHSE:603806) A Risky Investment?

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. As with many other companies Hangzhou First Applied Material Co., Ltd. (SHSE:603806) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hangzhou First Applied Material

How Much Debt Does Hangzhou First Applied Material Carry?

You can click the graphic below for the historical numbers, but it shows that Hangzhou First Applied Material had CN¥3.53b of debt in September 2024, down from CN¥4.52b, one year before. However, its balance sheet shows it holds CN¥4.60b in cash, so it actually has CN¥1.07b net cash.

How Strong Is Hangzhou First Applied Material's Balance Sheet?

The latest balance sheet data shows that Hangzhou First Applied Material had liabilities of CN¥1.99b due within a year, and liabilities of CN¥3.11b falling due after that. On the other hand, it had cash of CN¥4.60b and CN¥7.24b worth of receivables due within a year. So it can boast CN¥6.73b more liquid assets than total liabilities.

This surplus suggests that Hangzhou First Applied Material is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Hangzhou First Applied Material boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Hangzhou First Applied Material grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hangzhou First Applied Material can strengthen its balance sheet over time. 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. Hangzhou First Applied Material 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. Looking at the most recent three years, Hangzhou First Applied Material recorded free cash flow of 21% 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 Hangzhou First Applied Material has net cash of CN¥1.07b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 17% over the last year. So we don't think Hangzhou First Applied Material's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Hangzhou First Applied Material you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.