China High Speed Transmission Equipment Group (HKG:658) Seems To Use Debt Quite 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.' 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. We note that China High Speed Transmission Equipment Group Co., Ltd. (HKG:658) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China High Speed Transmission Equipment Group

What Is China High Speed Transmission Equipment Group's Debt?

The image below, which you can click on for greater detail, shows that China High Speed Transmission Equipment Group had debt of CN¥2.38b at the end of December 2020, a reduction from CN¥5.24b over a year. However, its balance sheet shows it holds CN¥6.12b in cash, so it actually has CN¥3.74b net cash.

How Healthy Is China High Speed Transmission Equipment Group's Balance Sheet?

According to the last reported balance sheet, China High Speed Transmission Equipment Group had liabilities of CN¥12.5b due within 12 months, and liabilities of CN¥682.9m due beyond 12 months. On the other hand, it had cash of CN¥6.12b and CN¥4.74b worth of receivables due within a year. So its liabilities total CN¥2.36b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since China High Speed Transmission Equipment Group has a market capitalization of CN¥9.26b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, China High Speed Transmission Equipment Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, China High Speed Transmission Equipment Group grew its EBIT by 102% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China High Speed Transmission Equipment Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China High Speed Transmission Equipment 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. Over the most recent three years, China High Speed Transmission Equipment Group recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although China High Speed Transmission Equipment Group'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¥3.74b. And it impressed us with its EBIT growth of 102% over the last year. So is China High Speed Transmission Equipment Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China High Speed Transmission Equipment Group is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.

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