Hengan International Group (HKG:1044) Has A Rock Solid Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Hengan International Group Company Limited (HKG:1044) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hengan International Group

What Is Hengan International Group's Net Debt?

As you can see below, at the end of June 2023, Hengan International Group had CN¥23.9b of debt, up from CN¥22.9b a year ago. Click the image for more detail. But it also has CN¥26.7b in cash to offset that, meaning it has CN¥2.89b net cash.

How Healthy Is Hengan International Group's Balance Sheet?

According to the last reported balance sheet, Hengan International Group had liabilities of CN¥27.7b due within 12 months, and liabilities of CN¥406.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥26.7b as well as receivables valued at CN¥4.55b due within 12 months. So it actually has CN¥3.18b more liquid assets than total liabilities.

This short term liquidity is a sign that Hengan International Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hengan International Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Hengan International Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hengan International Group can strengthen its balance sheet over time. 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. Hengan International 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. During the last three years, Hengan International Group generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hengan International Group has net cash of CN¥2.89b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.0b, being 86% of its EBIT. So we don't think Hengan International Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Hengan International Group you should be aware of.

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. 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.