Huagong Tech (SZSE:000988) 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.' 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 Huagong Tech Company Limited (SZSE:000988) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huagong Tech

What Is Huagong Tech's Debt?

The image below, which you can click on for greater detail, shows that Huagong Tech had debt of CN¥2.93b at the end of March 2024, a reduction from CN¥3.60b over a year. However, its balance sheet shows it holds CN¥4.32b in cash, so it actually has CN¥1.39b net cash.

How Healthy Is Huagong Tech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huagong Tech had liabilities of CN¥5.11b due within 12 months and liabilities of CN¥3.00b due beyond that. On the other hand, it had cash of CN¥4.32b and CN¥5.06b worth of receivables due within a year. So it actually has CN¥1.27b more liquid assets than total liabilities.

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

On the other hand, Huagong Tech saw its EBIT drop by 8.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Huagong Tech'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Huagong Tech 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. During the last three years, Huagong Tech produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huagong Tech has CN¥1.39b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in CN¥690m. So we don't think Huagong Tech'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. To that end, you should be aware of the 1 warning sign we've spotted with Huagong Tech .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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