We Think Huizhou Speed Wireless TechnologyLtd (SZSE:300322) Is Taking Some Risk With Its Debt

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.' 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 Huizhou Speed Wireless Technology Co.,Ltd. (SZSE:300322) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Huizhou Speed Wireless TechnologyLtd

How Much Debt Does Huizhou Speed Wireless TechnologyLtd Carry?

The chart below, which you can click on for greater detail, shows that Huizhou Speed Wireless TechnologyLtd had CN¥1.11b in debt in September 2024; about the same as the year before. On the flip side, it has CN¥318.3m in cash leading to net debt of about CN¥793.4m.

A Look At Huizhou Speed Wireless TechnologyLtd's Liabilities

According to the last reported balance sheet, Huizhou Speed Wireless TechnologyLtd had liabilities of CN¥1.62b due within 12 months, and liabilities of CN¥227.3m due beyond 12 months. Offsetting this, it had CN¥318.3m in cash and CN¥893.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥639.3m.

Since publicly traded Huizhou Speed Wireless TechnologyLtd shares are worth a total of CN¥7.04b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.28 times and a disturbingly high net debt to EBITDA ratio of 8.2 hit our confidence in Huizhou Speed Wireless TechnologyLtd like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Huizhou Speed Wireless TechnologyLtd is that it turned last year's EBIT loss into a gain of CN¥6.9m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Huizhou Speed Wireless TechnologyLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Huizhou Speed Wireless TechnologyLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Huizhou Speed Wireless TechnologyLtd's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Huizhou Speed Wireless TechnologyLtd's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Huizhou Speed Wireless TechnologyLtd that you should be aware of before investing here.

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.