Is New Focus Auto Tech Holdings (HKG:360) Using Debt Sensibly?

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. As with many other companies New Focus Auto Tech Holdings Limited (HKG:360) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

See our latest analysis for New Focus Auto Tech Holdings

How Much Debt Does New Focus Auto Tech Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2022 New Focus Auto Tech Holdings had debt of CN¥381.7m, up from CN¥339.0m in one year. But it also has CN¥672.3m in cash to offset that, meaning it has CN¥290.5m net cash.

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

According to the last reported balance sheet, New Focus Auto Tech Holdings had liabilities of CN¥744.1m due within 12 months, and liabilities of CN¥124.6m due beyond 12 months. On the other hand, it had cash of CN¥672.3m and CN¥91.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥104.9m.

This deficit isn't so bad because New Focus Auto Tech Holdings is worth CN¥328.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 it is New Focus Auto Tech Holdings's earnings that will influence how the balance sheet holds up in the future. 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 35%, to CN¥598m. That makes us nervous, to say the least.

So How Risky Is New Focus Auto Tech Holdings?

While New Focus Auto Tech Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥40m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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 2 warning signs for New Focus Auto Tech Holdings (1 can't be ignored) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.