Would Huazhang Technology Holding (HKG:1673) Be Better Off With Less Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Huazhang Technology Holding Limited (HKG:1673) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huazhang Technology Holding

What Is Huazhang Technology Holding's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Huazhang Technology Holding had debt of CN¥82.1m, up from CN¥51.6m in one year. However, because it has a cash reserve of CN¥77.3m, its net debt is less, at about CN¥4.75m.

How Healthy Is Huazhang Technology Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huazhang Technology Holding had liabilities of CN¥592.6m due within 12 months and liabilities of CN¥28.2m due beyond that. Offsetting this, it had CN¥77.3m in cash and CN¥277.3m in receivables that were due within 12 months. So it has liabilities totalling CN¥266.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥391.6m, so it does suggest shareholders should keep an eye on Huazhang Technology Holding's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Carrying virtually no net debt, Huazhang Technology Holding has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is Huazhang Technology Holding's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Huazhang Technology Holding reported revenue of CN¥529m, which is a gain of 63%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Huazhang Technology Holding managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at CN¥30m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥126m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Huazhang Technology Holding has 4 warning signs (and 2 which are significant) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.