Shanghai Haohai Biological Technology (HKG:6826) Seems To Use Debt Rather Sparingly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Shanghai Haohai Biological Technology Co., Ltd. (HKG:6826) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shanghai Haohai Biological Technology

What Is Shanghai Haohai Biological Technology's Net Debt?

As you can see below, Shanghai Haohai Biological Technology had CN¥37.7m of debt at June 2021, down from CN¥64.9m a year prior. However, it does have CN¥3.14b in cash offsetting this, leading to net cash of CN¥3.10b.

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¥512.1m due within a year, and liabilities of CN¥140.5m falling due after that. Offsetting this, it had CN¥3.14b in cash and CN¥408.2m in receivables that were due within 12 months. So it can boast CN¥2.90b 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 852% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Haohai Biological Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shanghai Haohai Biological Technology 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. Looking at the most recent three years, Shanghai Haohai Biological Technology recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Shanghai Haohai Biological Technology has CN¥3.10b in net cash and a decent-looking balance sheet. And we liked the look of last year's 852% year-on-year EBIT growth. So is Shanghai Haohai Biological Technology'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. However, not all investment risk resides within the balance sheet - far from it. For example - Shanghai Haohai Biological Technology has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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