Health Check: How Prudently Does Hengdeli Holdings (HKG:3389) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Hengdeli Holdings Limited (HKG:3389) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

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What Is Hengdeli Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Hengdeli Holdings had CN¥77.3m in debt in June 2022; about the same as the year before. But on the other hand it also has CN¥1.06b in cash, leading to a CN¥978.4m net cash position.

A Look At Hengdeli Holdings' Liabilities

We can see from the most recent balance sheet that Hengdeli Holdings had liabilities of CN¥201.6m falling due within a year, and liabilities of CN¥32.4m due beyond that. On the other hand, it had cash of CN¥1.06b and CN¥710.2m worth of receivables due within a year. So it can boast CN¥1.53b more liquid assets than total liabilities.

This surplus strongly suggests that Hengdeli Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Hengdeli Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. 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 wasn't profitable at an EBIT level, but managed to grow its revenue by 8.1%, to CN¥1.1b. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Hengdeli Holdings?

While Hengdeli Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥20m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. There's no doubt the next few years will be crucial to how the business matures. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hengdeli Holdings is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.