Health Check: How Prudently Does Hengdeli Holdings (HKG:3389) Use 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hengdeli Holdings Limited (HKG:3389) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hengdeli Holdings

How Much Debt Does Hengdeli Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Hengdeli Holdings had CN¥140.9m of debt in June 2020, down from CN¥146.8m, one year before. But on the other hand it also has CN¥1.38b in cash, leading to a CN¥1.24b net cash position.

How Healthy Is Hengdeli Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hengdeli Holdings had liabilities of CN¥311.1m due within 12 months and liabilities of CN¥109.5m due beyond that. Offsetting this, it had CN¥1.38b in cash and CN¥541.3m in receivables that were due within 12 months. So it can boast CN¥1.50b more liquid assets than total liabilities.

This excess liquidity is a great indication that Hengdeli Holdings's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Hengdeli Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hengdeli Holdings'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.

In the last year Hengdeli Holdings had a loss before interest and tax, and actually shrunk its revenue by 37%, to CN¥1.7b. To be frank that doesn't bode well.

So How Risky Is Hengdeli Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Hengdeli Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CN¥16m and booked a CN¥433m accounting loss. Given it only has net cash of CN¥1.24b, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Hengdeli Holdings , and understanding them should be part of your investment process.

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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