Is HengTen Networks Group (HKG:136) Using Too Much 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 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 HengTen Networks Group Limited (HKG:136) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for HengTen Networks Group

What Is HengTen Networks Group's Debt?

You can click the graphic below for the historical numbers, but it shows that HengTen Networks Group had CN¥27.3m of debt in June 2020, down from CN¥52.6m, one year before. However, it does have CN¥1.10b in cash offsetting this, leading to net cash of CN¥1.07b.

How Healthy Is HengTen Networks Group's Balance Sheet?

According to the last reported balance sheet, HengTen Networks Group had liabilities of CN¥145.4m due within 12 months, and liabilities of CN¥10.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥106.4m due within 12 months. So it can boast CN¥1.05b more liquid assets than total liabilities.

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

It is just as well that HengTen Networks Group's load is not too heavy, because its EBIT was down 68% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is HengTen Networks Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. HengTen Networks Group 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 most recent three years, HengTen Networks Group recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HengTen Networks Group has net cash of CN¥1.07b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of -CN¥58m, being 78% of its EBIT. So we are not troubled with HengTen Networks Group's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with HengTen Networks Group , and understanding them should be part of your investment process.

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.

If you’re looking to trade HengTen Networks Group, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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