Is China High Speed Transmission Equipment Group (HKG:658) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, China High Speed Transmission Equipment Group Co., Ltd. (HKG:658) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

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

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

The image below, which you can click on for greater detail, shows that China High Speed Transmission Equipment Group had debt of CN¥4.58b at the end of June 2020, a reduction from CN¥5.97b over a year. But on the other hand it also has CN¥6.38b in cash, leading to a CN¥1.80b net cash position.

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¥13.9b due within a year, and liabilities of CN¥506.6m falling due after that. Offsetting these obligations, it had cash of CN¥6.38b as well as receivables valued at CN¥4.42b due within 12 months. So its liabilities total CN¥3.60b 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¥8.58b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. 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!

Pleasingly, China High Speed Transmission Equipment Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 112% gain in the last twelve months. 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 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.

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 last three years, China High Speed Transmission Equipment Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

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¥1.80b. And it impressed us with free cash flow of CN¥2.2b, being 150% of its EBIT. So is China High Speed Transmission Equipment Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for China High Speed Transmission Equipment Group you should be aware of, and 1 of them is a bit unpleasant.

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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