Is Huabao International Holdings (HKG:336) A Risky Investment?

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. As with many other companies Huabao International Holdings Limited (HKG:336) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huabao International Holdings

What Is Huabao International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Huabao International Holdings had debt of CN¥2.71b at the end of December 2020, a reduction from CN¥3.00b over a year. However, it does have CN¥6.91b in cash offsetting this, leading to net cash of CN¥4.20b.

A Look At Huabao International Holdings' Liabilities

The latest balance sheet data shows that Huabao International Holdings had liabilities of CN¥1.97b due within a year, and liabilities of CN¥2.02b falling due after that. On the other hand, it had cash of CN¥6.91b and CN¥1.10b worth of receivables due within a year. So it can boast CN¥4.02b more liquid assets than total liabilities.

This surplus suggests that Huabao International Holdings is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Huabao International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Huabao International Holdings has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Huabao International Holdings 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Huabao International Holdings 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, Huabao International Holdings produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Huabao International Holdings has CN¥4.20b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.3b, being 78% of its EBIT. So is Huabao International 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 Huabao International Holdings (1 is significant) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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