Is Huagong Tech (SZSE:000988) Using Too Much Debt?

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. We note that Huagong Tech Company Limited (SZSE:000988) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Huagong Tech

What Is Huagong Tech's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Huagong Tech had debt of CN¥3.44b, up from CN¥3.18b in one year. But it also has CN¥3.71b in cash to offset that, meaning it has CN¥267.3m net cash.

How Strong Is Huagong Tech's Balance Sheet?

The latest balance sheet data shows that Huagong Tech had liabilities of CN¥7.04b due within a year, and liabilities of CN¥2.64b falling due after that. Offsetting this, it had CN¥3.71b in cash and CN¥6.35b in receivables that were due within 12 months. So it can boast CN¥376.9m more liquid assets than total liabilities.

This state of affairs indicates that Huagong Tech's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥41.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Huagong Tech has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Huagong Tech grew its EBIT by 5.3% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. 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. Huagong Tech 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, Huagong Tech's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huagong Tech has net cash of CN¥267.3m, as well as more liquid assets than liabilities. And it also grew its EBIT by 5.3% over the last year. So we are not troubled with Huagong Tech's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Huagong Tech .

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.