Is China High Speed Transmission Equipment Group (HKG:658) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 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 A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for China High Speed Transmission Equipment Group

How Much Debt Does China High Speed Transmission Equipment Group Carry?

The image below, which you can click on for greater detail, shows that China High Speed Transmission Equipment Group had debt of CN¥3.05b at the end of June 2021, a reduction from CN¥4.58b over a year. However, its balance sheet shows it holds CN¥5.38b in cash, so it actually has CN¥2.32b net cash.

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

Zooming in on the latest balance sheet data, we can see that China High Speed Transmission Equipment Group had liabilities of CN¥14.7b due within 12 months and liabilities of CN¥731.7m due beyond that. On the other hand, it had cash of CN¥5.38b and CN¥6.45b worth of receivables due within a year. So its liabilities total CN¥3.64b 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¥8.22b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, China High Speed Transmission Equipment Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that China High Speed Transmission Equipment Group has boosted its EBIT by 87%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China High Speed Transmission Equipment 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. 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 52% 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

While China High Speed Transmission Equipment Group does have more liabilities than liquid assets, it also has net cash of CN¥2.32b. And it impressed us with its EBIT growth of 87% over the last year. So we are not troubled with China High Speed Transmission Equipment Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. 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 1 warning sign in our investment analysis , you should know about...

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.