These 4 Measures Indicate That Hangzhou Cogeneration Group (SHSE:605011) Is Using Debt Safely

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.' 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. Importantly, Hangzhou Cogeneration Group Co., Ltd. (SHSE:605011) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hangzhou Cogeneration Group

What Is Hangzhou Cogeneration Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Hangzhou Cogeneration Group had CN¥650.1m of debt in March 2024, down from CN¥956.9m, one year before. But it also has CN¥673.7m in cash to offset that, meaning it has CN¥23.6m net cash.

How Strong Is Hangzhou Cogeneration Group's Balance Sheet?

The latest balance sheet data shows that Hangzhou Cogeneration Group had liabilities of CN¥740.0m due within a year, and liabilities of CN¥343.0m falling due after that. Offsetting these obligations, it had cash of CN¥673.7m as well as receivables valued at CN¥385.0m due within 12 months. So it has liabilities totalling CN¥24.2m more than its cash and near-term receivables, combined.

Having regard to Hangzhou Cogeneration Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥10.4b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Hangzhou Cogeneration Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Hangzhou Cogeneration Group grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hangzhou Cogeneration Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hangzhou Cogeneration Group 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, Hangzhou Cogeneration Group generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Hangzhou Cogeneration Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥23.6m. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in CN¥287m. So we don't think Hangzhou Cogeneration Group's use of debt is risky. 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. For instance, we've identified 1 warning sign for Hangzhou Cogeneration Group that you should be aware of.

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.

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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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