Is Zhuzhou Hongda ElectronicsLtd (SZSE:300726) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zhuzhou Hongda Electronics Corp.,Ltd. (SZSE:300726) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Zhuzhou Hongda ElectronicsLtd

What Is Zhuzhou Hongda ElectronicsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhuzhou Hongda ElectronicsLtd had CN¥12.0m of debt in September 2024, down from CN¥15.0m, one year before. However, its balance sheet shows it holds CN¥1.55b in cash, so it actually has CN¥1.54b net cash.

How Strong Is Zhuzhou Hongda ElectronicsLtd's Balance Sheet?

The latest balance sheet data shows that Zhuzhou Hongda ElectronicsLtd had liabilities of CN¥451.8m due within a year, and liabilities of CN¥189.9m falling due after that. Offsetting these obligations, it had cash of CN¥1.55b as well as receivables valued at CN¥1.94b due within 12 months. So it actually has CN¥2.85b more liquid assets than total liabilities.

It's good to see that Zhuzhou Hongda ElectronicsLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Zhuzhou Hongda ElectronicsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Zhuzhou Hongda ElectronicsLtd if management cannot prevent a repeat of the 46% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Zhuzhou Hongda ElectronicsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhuzhou Hongda ElectronicsLtd 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, Zhuzhou Hongda ElectronicsLtd produced sturdy free cash flow equating to 52% 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 Zhuzhou Hongda ElectronicsLtd has CN¥1.54b in net cash and a decent-looking balance sheet. So we are not troubled with Zhuzhou Hongda ElectronicsLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Zhuzhou Hongda ElectronicsLtd is showing 3 warning signs in our investment analysis , you should know about...

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.