These 4 Measures Indicate That Sany Heavy Equipment International Holdings (HKG:631) Is Using Debt Reasonably Well

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.' 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. We can see that Sany Heavy Equipment International Holdings Company Limited (HKG:631) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sany Heavy Equipment International Holdings

What Is Sany Heavy Equipment International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Sany Heavy Equipment International Holdings had debt of CN¥3.65b, up from CN¥3.46b in one year. However, its balance sheet shows it holds CN¥4.78b in cash, so it actually has CN¥1.13b net cash.

A Look At Sany Heavy Equipment International Holdings' Liabilities

According to the last reported balance sheet, Sany Heavy Equipment International Holdings had liabilities of CN¥10.8b due within 12 months, and liabilities of CN¥4.01b due beyond 12 months. Offsetting this, it had CN¥4.78b in cash and CN¥7.50b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.58b.

Since publicly traded Sany Heavy Equipment International Holdings shares are worth a total of CN¥22.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Sany Heavy Equipment International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Sany Heavy Equipment International Holdings has boosted its EBIT by 82%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sany Heavy Equipment International Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sany Heavy Equipment International Holdings 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. In the last three years, Sany Heavy Equipment International Holdings created free cash flow amounting to 4.7% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although Sany Heavy Equipment International Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.13b. And we liked the look of last year's 82% year-on-year EBIT growth. So we are not troubled with Sany Heavy Equipment International Holdings's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Sany Heavy Equipment International Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.