China High Speed Transmission Equipment Group (HKG:658) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies China High Speed Transmission Equipment Group Co., Ltd. (HKG:658) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China High Speed Transmission Equipment Group

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

As you can see below, at the end of December 2021, China High Speed Transmission Equipment Group had CN¥4.00b of debt, up from CN¥2.38b a year ago. Click the image for more detail. But it also has CN¥6.96b in cash to offset that, meaning it has CN¥2.96b net cash.

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

The latest balance sheet data shows that China High Speed Transmission Equipment Group had liabilities of CN¥14.7b due within a year, and liabilities of CN¥1.15b falling due after that. On the other hand, it had cash of CN¥6.96b and CN¥5.43b worth of receivables due within a year. So its liabilities total CN¥3.49b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because China High Speed Transmission Equipment Group is worth CN¥7.11b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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!

And we also note warmly that China High Speed Transmission Equipment Group grew its EBIT by 15% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China High Speed Transmission Equipment Group'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China High Speed Transmission Equipment Group 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, China High Speed Transmission Equipment Group's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While China High Speed Transmission Equipment Group does have more liabilities than liquid assets, it also has net cash of CN¥2.96b. And we liked the look of last year's 15% year-on-year EBIT growth. So we are not troubled with China High Speed Transmission Equipment Group's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China High Speed Transmission Equipment Group's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.