These 4 Measures Indicate That Fujian Highton Development (SHSE:603162) Is Using Debt Reasonably Well

Warren Buffett famously said, '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 Fujian Highton Development Co., Ltd. (SHSE:603162) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fujian Highton Development

How Much Debt Does Fujian Highton Development Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Fujian Highton Development had debt of CN¥50.0m, up from none in one year. But it also has CN¥950.8m in cash to offset that, meaning it has CN¥900.8m net cash.

A Look At Fujian Highton Development's Liabilities

According to the last reported balance sheet, Fujian Highton Development had liabilities of CN¥480.3m due within 12 months, and liabilities of CN¥330.5m due beyond 12 months. On the other hand, it had cash of CN¥950.8m and CN¥375.7m worth of receivables due within a year. So it can boast CN¥515.8m more liquid assets than total liabilities.

This surplus suggests that Fujian Highton Development has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Fujian Highton Development boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Fujian Highton Development if management cannot prevent a repeat of the 74% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fujian Highton Development will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Fujian Highton Development 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 last three years, Fujian Highton Development reported free cash flow worth 14% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Fujian Highton Development has net cash of CN¥900.8m, as well as more liquid assets than liabilities. So we are not troubled with Fujian Highton Development's debt use. 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. To that end, you should learn about the 3 warning signs we've spotted with Fujian Highton Development (including 1 which makes us a bit uncomfortable) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com