Sichuan Haite High-techLtd (SZSE:002023) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Sichuan Haite High-tech Co.,Ltd. (SZSE:002023) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Sichuan Haite High-techLtd

What Is Sichuan Haite High-techLtd's Debt?

As you can see below, at the end of March 2024, Sichuan Haite High-techLtd had CN¥2.32b of debt, up from CN¥1.87b a year ago. Click the image for more detail. On the flip side, it has CN¥630.7m in cash leading to net debt of about CN¥1.69b.

How Strong Is Sichuan Haite High-techLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sichuan Haite High-techLtd had liabilities of CN¥1.23b due within 12 months and liabilities of CN¥1.79b due beyond that. Offsetting this, it had CN¥630.7m in cash and CN¥737.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.66b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Sichuan Haite High-techLtd has a market capitalization of CN¥7.98b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

While Sichuan Haite High-techLtd's debt to EBITDA ratio (4.7) suggests that it uses some debt, its interest cover is very weak, at 1.8, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. On a lighter note, we note that Sichuan Haite High-techLtd grew its EBIT by 21% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sichuan Haite High-techLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent two years, Sichuan Haite High-techLtd recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Sichuan Haite High-techLtd's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But its EBIT growth rate was significantly redeeming. It's also worth noting that Sichuan Haite High-techLtd is in the Infrastructure industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Sichuan Haite High-techLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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 Sichuan Haite High-techLtd you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.