Is Huazhang Technology Holding (HKG:1673) Using Too Much Debt?

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.' 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, Huazhang Technology Holding Limited (HKG:1673) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Huazhang Technology Holding

How Much Debt Does Huazhang Technology Holding Carry?

You can click the graphic below for the historical numbers, but it shows that Huazhang Technology Holding had CN¥147.9m of debt in June 2021, down from CN¥222.0m, one year before. However, it does have CN¥188.8m in cash offsetting this, leading to net cash of CN¥40.9m.

How Healthy Is Huazhang Technology Holding's Balance Sheet?

According to the last reported balance sheet, Huazhang Technology Holding had liabilities of CN¥667.0m due within 12 months, and liabilities of CN¥34.8m due beyond 12 months. On the other hand, it had cash of CN¥188.8m and CN¥566.7m worth of receivables due within a year. So it can boast CN¥53.7m more liquid assets than total liabilities.

This surplus suggests that Huazhang Technology Holding has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Huazhang Technology Holding boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Huazhang Technology Holding improved its EBIT from a last year's loss to a positive CN¥27m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Huazhang Technology Holding 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Huazhang Technology Holding 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. Over the last year, Huazhang Technology Holding actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Huazhang Technology Holding has CN¥40.9m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥116m, being 428% of its EBIT. So is Huazhang Technology Holding's debt a risk? It doesn't seem so to us. 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. We've identified 4 warning signs with Huazhang Technology Holding , and understanding them should be part of your investment process.

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.

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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