Is Hengdeli Holdings (HKG:3389) Weighed On By Its Debt Load?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Hengdeli Holdings

How Much Debt Does Hengdeli Holdings Carry?

The image below, which you can click on for greater detail, shows that Hengdeli Holdings had debt of CN¥29.9m at the end of December 2020, a reduction from CN¥216.6m over a year. However, its balance sheet shows it holds CN¥1.27b in cash, so it actually has CN¥1.24b net cash.

How Strong Is Hengdeli Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hengdeli Holdings had liabilities of CN¥137.3m due within 12 months and liabilities of CN¥51.3m due beyond that. Offsetting this, it had CN¥1.27b in cash and CN¥451.8m in receivables that were due within 12 months. So it actually has CN¥1.53b more liquid assets than total liabilities.

This excess liquidity is a great indication that Hengdeli Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. 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 you can't view debt in total isolation; since Hengdeli Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Hengdeli Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥1.2b, which is a fall of 49%. To be frank that doesn't bode well.

So How Risky Is Hengdeli Holdings?

While Hengdeli Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥37m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hengdeli Holdings that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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