Is Shanghai Haohai Biological Technology (HKG:6826) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shanghai Haohai Biological Technology Co., Ltd. (HKG:6826) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Haohai Biological Technology

What Is Shanghai Haohai Biological Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Shanghai Haohai Biological Technology had debt of CN¥58.8m at the end of December 2021, a reduction from CN¥79.4m over a year. But on the other hand it also has CN¥2.91b in cash, leading to a CN¥2.85b net cash position.

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

The latest balance sheet data shows that Shanghai Haohai Biological Technology had liabilities of CN¥487.3m due within a year, and liabilities of CN¥402.8m falling due after that. On the other hand, it had cash of CN¥2.91b and CN¥389.7m worth of receivables due within a year. So it actually has CN¥2.41b more liquid assets than total liabilities.

This excess liquidity suggests that Shanghai Haohai Biological Technology is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Shanghai Haohai Biological Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Shanghai Haohai Biological Technology grew its EBIT by 118% over twelve months. 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 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. In the last three years, Shanghai Haohai Biological Technology created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Shanghai Haohai Biological Technology has CN¥2.85b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 118% over the last year. So we don't think Shanghai Haohai Biological Technology's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Shanghai Haohai Biological Technology .

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.

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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.