Does Huayu Expressway Group (HKG:1823) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 can see that Huayu Expressway Group Limited (HKG:1823) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Huayu Expressway Group

What Is Huayu Expressway Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Huayu Expressway Group had CN¥187.3m of debt, an increase on CN¥50.0m, over one year. However, it does have CN¥276.3m in cash offsetting this, leading to net cash of CN¥89.0m.

A Look At Huayu Expressway Group's Liabilities

The latest balance sheet data shows that Huayu Expressway Group had liabilities of CN¥274.4m due within a year, and liabilities of CN¥38.2m falling due after that. Offsetting these obligations, it had cash of CN¥276.3m as well as receivables valued at CN¥63.0m due within 12 months. So it actually has CN¥26.7m more liquid assets than total liabilities.

This surplus suggests that Huayu Expressway Group is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Huayu Expressway Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Huayu Expressway Group's load is not too heavy, because its EBIT was down 94% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Huayu Expressway Group 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. Huayu Expressway Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Huayu Expressway Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huayu Expressway Group has CN¥89.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥14m, being 393% of its EBIT. So we don't think Huayu Expressway Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Huayu Expressway Group is showing 5 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.