Is Shanghai Haohai Biological Technology (HKG:6826) A Risky Investment?

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 can see that Shanghai Haohai Biological Technology Co., Ltd. (HKG:6826) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shanghai Haohai Biological Technology

What Is Shanghai Haohai Biological Technology's Debt?

As you can see below, Shanghai Haohai Biological Technology had CN¥66.1m of debt at September 2021, down from CN¥81.4m a year prior. But it also has CN¥2.91b in cash to offset that, meaning it has CN¥2.84b net cash.

How Strong Is Shanghai Haohai Biological Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Haohai Biological Technology had liabilities of CN¥428.8m due within 12 months and liabilities of CN¥226.4m due beyond that. Offsetting these obligations, it had cash of CN¥2.91b as well as receivables valued at CN¥463.4m due within 12 months. So it can boast CN¥2.72b more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Haohai Biological Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shanghai Haohai Biological Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Shanghai Haohai Biological Technology grew its EBIT by 779% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Haohai Biological Technology's ability to maintain a healthy balance sheet going forward. 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. Shanghai Haohai Biological Technology 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. Over the last three years, Shanghai Haohai Biological Technology reported free cash flow worth 12% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Shanghai Haohai Biological Technology has CN¥2.84b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 779% over the last year. So is Shanghai Haohai Biological Technology's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shanghai Haohai Biological Technology's earnings per share history for free.

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.