Huagong Tech (SZSE:000988) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Huagong Tech Company Limited (SZSE:000988) makes use of 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, 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.

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¥3.18b at the end of September 2023, a reduction from CN¥3.47b over a year. But it also has CN¥4.43b in cash to offset that, meaning it has CN¥1.25b net cash.

How Healthy Is Huagong Tech's Balance Sheet?

According to the last reported balance sheet, Huagong Tech had liabilities of CN¥5.33b due within 12 months, and liabilities of CN¥3.16b due beyond 12 months. Offsetting this, it had CN¥4.43b in cash and CN¥5.00b in receivables that were due within 12 months. So it actually has CN¥931.5m 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 top of that, Huagong Tech grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. 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 Huagong Tech can strengthen its balance sheet over time. 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. Over the most recent three years, Huagong Tech recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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¥1.25b in net cash and a decent-looking balance sheet. And we liked the look of last year's 47% year-on-year EBIT growth. 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Huagong Tech that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.