We Think China Leon Inspection Holding (HKG:1586) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, China Leon Inspection Holding Limited (HKG:1586) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Leon Inspection Holding

What Is China Leon Inspection Holding's Net Debt?

The image below, which you can click on for greater detail, shows that China Leon Inspection Holding had debt of HK$77.3m at the end of December 2022, a reduction from HK$80.9m over a year. However, its balance sheet shows it holds HK$231.6m in cash, so it actually has HK$154.3m net cash.

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 HK$181.6m due within 12 months and liabilities of HK$91.5m due beyond that. Offsetting this, it had HK$231.6m in cash and HK$172.3m in receivables that were due within 12 months. So it actually has HK$130.9m 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. Simply put, the fact that China Leon Inspection Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, China Leon Inspection Holding grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Leon Inspection Holding's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, China Leon Inspection Holding generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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 HK$154.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$127m, being 91% of its EBIT. So is China Leon Inspection Holding'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. To that end, you should be aware of the 1 warning sign we've spotted with China Leon Inspection Holding .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.