Is Harbin Electric (HKG:1133) Using Debt Sensibly?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Harbin Electric Company Limited (HKG:1133) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Harbin Electric

How Much Debt Does Harbin Electric Carry?

The image below, which you can click on for greater detail, shows that at June 2021 Harbin Electric had debt of CN¥7.92b, up from CN¥6.52b in one year. However, it does have CN¥11.8b in cash offsetting this, leading to net cash of CN¥3.88b.

A Look At Harbin Electric's Liabilities

The latest balance sheet data shows that Harbin Electric had liabilities of CN¥40.1b due within a year, and liabilities of CN¥3.68b falling due after that. Offsetting these obligations, it had cash of CN¥11.8b as well as receivables valued at CN¥24.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.50b.

This deficit casts a shadow over the CN¥4.81b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Harbin Electric would probably need a major re-capitalization if its creditors were to demand repayment. Harbin Electric boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Harbin Electric'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.

Over 12 months, Harbin Electric reported revenue of CN¥26b, which is a gain of 17%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Harbin Electric?

Although Harbin Electric had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥2.3b. 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. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. For riskier companies like Harbin Electric I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.