Diwang Industrial Holdings (HKG:1950) Could Easily Take On More Debt

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 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. Importantly, Diwang Industrial Holdings Limited (HKG:1950) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Diwang Industrial Holdings

What Is Diwang Industrial Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Diwang Industrial Holdings had debt of CN¥25.0m, up from CN¥10.0m in one year. But on the other hand it also has CN¥37.5m in cash, leading to a CN¥12.5m net cash position.

A Look At Diwang Industrial Holdings' Liabilities

We can see from the most recent balance sheet that Diwang Industrial Holdings had liabilities of CN¥107.3m falling due within a year, and liabilities of CN¥3.84m due beyond that. Offsetting these obligations, it had cash of CN¥37.5m as well as receivables valued at CN¥166.3m due within 12 months. So it actually has CN¥92.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Diwang Industrial Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Diwang Industrial Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Diwang Industrial Holdings grew its EBIT by 205% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Diwang Industrial Holdings's earnings that will influence how the balance sheet holds up in the future. 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. While Diwang Industrial Holdings 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. During the last three years, Diwang Industrial Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Diwang Industrial Holdings has CN¥12.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 205% year-on-year EBIT growth. So is Diwang Industrial Holdings'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Diwang Industrial Holdings (2 are a bit concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.