These 4 Measures Indicate That Hengdian Group DMEGC Magnetics Ltd (SZSE:002056) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Hengdian Group DMEGC Magnetics Co. ,Ltd (SZSE:002056) makes use of debt. But should shareholders be worried about its use of debt?

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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hengdian Group DMEGC Magnetics Ltd

What Is Hengdian Group DMEGC Magnetics Ltd's Debt?

As you can see below, at the end of March 2024, Hengdian Group DMEGC Magnetics Ltd had CN¥2.79b of debt, up from CN¥1.41b a year ago. Click the image for more detail. However, it does have CN¥8.41b in cash offsetting this, leading to net cash of CN¥5.61b.

How Healthy Is Hengdian Group DMEGC Magnetics Ltd's Balance Sheet?

We can see from the most recent balance sheet that Hengdian Group DMEGC Magnetics Ltd had liabilities of CN¥11.8b falling due within a year, and liabilities of CN¥641.6m due beyond that. On the other hand, it had cash of CN¥8.41b and CN¥3.60b worth of receivables due within a year. So its liabilities total CN¥450.7m more than the combination of its cash and short-term receivables.

Since publicly traded Hengdian Group DMEGC Magnetics Ltd shares are worth a total of CN¥19.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Hengdian Group DMEGC Magnetics Ltd also has more cash than debt, so we're pretty confident it can manage its debt safely.

While Hengdian Group DMEGC Magnetics Ltd doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hengdian Group DMEGC Magnetics Ltd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hengdian Group DMEGC Magnetics Ltd 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, Hengdian Group DMEGC Magnetics Ltd recorded free cash flow worth 76% 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 look at a company's total liabilities, it is very reassuring that Hengdian Group DMEGC Magnetics Ltd has CN¥5.61b in net cash. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in CN¥2.1b. So we don't think Hengdian Group DMEGC Magnetics Ltd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Hengdian Group DMEGC Magnetics Ltd you should be aware of.

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.

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