Is New Focus Auto Tech Holdings (HKG:360) Using Debt In A Risky Way?

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. Importantly, New Focus Auto Tech Holdings Limited (HKG:360) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

View our latest analysis for New Focus Auto Tech Holdings

What Is New Focus Auto Tech Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that New Focus Auto Tech Holdings had CN¥339.0m of debt in June 2021, down from CN¥369.9m, one year before. However, its balance sheet shows it holds CN¥638.8m in cash, so it actually has CN¥299.8m net cash.

How Strong Is New Focus Auto Tech Holdings' Balance Sheet?

The latest balance sheet data shows that New Focus Auto Tech Holdings had liabilities of CN¥808.2m due within a year, and liabilities of CN¥161.2m falling due after that. Offsetting these obligations, it had cash of CN¥638.8m as well as receivables valued at CN¥162.0m due within 12 months. So it has liabilities totalling CN¥168.6m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since New Focus Auto Tech Holdings has a market capitalization of CN¥387.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, New Focus Auto Tech Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since New Focus Auto Tech Holdings 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.

In the last year New Focus Auto Tech Holdings had a loss before interest and tax, and actually shrunk its revenue by 15%, to CN¥918m. That's not what we would hope to see.

So How Risky Is New Focus Auto Tech Holdings?

Although New Focus Auto Tech Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥15m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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 instance, we've identified 3 warning signs for New Focus Auto Tech Holdings (1 is a bit unpleasant) 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.

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.