Is HengTen Networks Group (HKG:136) Using Too Much Debt?

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 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 HengTen Networks Group Limited (HKG:136) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for HengTen Networks Group

What Is HengTen Networks Group's Net Debt?

As you can see below, at the end of June 2021, HengTen Networks Group had CN¥150.0m of debt, up from CN¥27.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥652.6m in cash, so it actually has CN¥502.6m net cash.

How Healthy Is HengTen Networks Group's Balance Sheet?

According to the last reported balance sheet, HengTen Networks Group had liabilities of CN¥2.33b due within 12 months, and liabilities of CN¥3.98b due beyond 12 months. Offsetting this, it had CN¥652.6m in cash and CN¥454.2m in receivables that were due within 12 months. So it has liabilities totalling CN¥5.21b more than its cash and near-term receivables, combined.

Given HengTen Networks Group has a market capitalization of CN¥28.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, HengTen Networks Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, HengTen Networks Group grew its EBIT by 628% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine HengTen Networks Group'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. 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 last three years, HengTen Networks Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While HengTen Networks Group does have more liabilities than liquid assets, it also has net cash of CN¥502.6m. And we liked the look of last year's 628% year-on-year EBIT growth. So we don't have any problem with HengTen Networks Group's use of debt. 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. Be aware that HengTen Networks Group is showing 2 warning signs in our investment analysis , you should know about...

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.

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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.
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