Here's Why China Leon Inspection Holding (HKG:1586) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies China Leon Inspection Holding Limited (HKG:1586) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Leon Inspection Holding

What Is China Leon Inspection Holding's Net Debt?

As you can see below, China Leon Inspection Holding had CN¥33.8m of debt at December 2020, down from CN¥63.3m a year prior. But on the other hand it also has CN¥78.9m in cash, leading to a CN¥45.0m net cash position.

How Healthy Is China Leon Inspection Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Leon Inspection Holding had liabilities of CN¥138.9m due within 12 months and liabilities of CN¥25.9m due beyond that. Offsetting these obligations, it had cash of CN¥78.9m as well as receivables valued at CN¥108.5m due within 12 months. So it actually has CN¥22.5m more liquid assets than total liabilities.

This short term liquidity is a sign that China Leon Inspection Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Leon Inspection Holding 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 China Leon Inspection Holding has boosted its EBIT by 75%, 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 Leon Inspection Holding will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Leon Inspection Holding 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. In the last three years, China Leon Inspection Holding created free cash flow amounting to 12% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Leon Inspection Holding has net cash of CN¥45.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 75% over the last year. So is China Leon Inspection Holding's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for China Leon Inspection Holding that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. 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.
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