Is Hexing ElectricalLtd (SHSE:603556) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Hexing Electrical Co.,Ltd. (SHSE:603556) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hexing ElectricalLtd

What Is Hexing ElectricalLtd's Debt?

The image below, which you can click on for greater detail, shows that Hexing ElectricalLtd had debt of CN¥428.4m at the end of March 2024, a reduction from CN¥537.0m over a year. However, its balance sheet shows it holds CN¥4.66b in cash, so it actually has CN¥4.24b net cash.

A Look At Hexing ElectricalLtd's Liabilities

According to the last reported balance sheet, Hexing ElectricalLtd had liabilities of CN¥2.02b due within 12 months, and liabilities of CN¥286.8m due beyond 12 months. Offsetting this, it had CN¥4.66b in cash and CN¥1.24b in receivables that were due within 12 months. So it actually has CN¥3.59b more liquid assets than total liabilities.

This surplus suggests that Hexing ElectricalLtd 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. Simply put, the fact that Hexing ElectricalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Hexing ElectricalLtd has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. 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 Hexing ElectricalLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hexing ElectricalLtd 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, Hexing ElectricalLtd generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hexing ElectricalLtd has net cash of CN¥4.24b, as well as more liquid assets than liabilities. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in CN¥1.2b. When it comes to Hexing ElectricalLtd's debt, we sufficiently relaxed that our mind turns to the jacuzzi. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Hexing ElectricalLtd .

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.

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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.