Hengan International Group (HKG:1044) Seems To Use Debt Quite Sensibly

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 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 note that Hengan International Group Company Limited (HKG:1044) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 Hengan International Group

How Much Debt Does Hengan International Group Carry?

The chart below, which you can click on for greater detail, shows that Hengan International Group had CN¥22.9b in debt in June 2022; about the same as the year before. However, its balance sheet shows it holds CN¥24.5b in cash, so it actually has CN¥1.63b net cash.

A Look At Hengan International Group's Liabilities

The latest balance sheet data shows that Hengan International Group had liabilities of CN¥24.8b due within a year, and liabilities of CN¥2.31b falling due after that. Offsetting these obligations, it had cash of CN¥24.5b as well as receivables valued at CN¥4.89b due within 12 months. So it actually has CN¥2.26b 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. Simply put, the fact that Hengan International Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Hengan International Group's load is not too heavy, because its EBIT was down 33% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hengan International Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Hengan International Group recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hengan International Group has CN¥1.63b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.7b, being 90% of its EBIT. So we are not troubled with Hengan International Group's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hengan International Group you should know about.

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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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.