These 4 Measures Indicate That China Harmony Auto Holding (HKG:3836) Is Using Debt In A Risky Way

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.' 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 note that China Harmony Auto Holding Limited (HKG:3836) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

How Much Debt Does China Harmony Auto Holding Carry?

As you can see below, at the end of June 2025, China Harmony Auto Holding had CN¥3.57b of debt, up from CN¥2.38b a year ago. Click the image for more detail. However, it does have CN¥1.10b in cash offsetting this, leading to net debt of about CN¥2.48b.

How Healthy Is China Harmony Auto Holding's Balance Sheet?

The latest balance sheet data shows that China Harmony Auto Holding had liabilities of CN¥5.57b due within a year, and liabilities of CN¥1.05b falling due after that. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥491.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.03b.

This deficit casts a shadow over the CN¥2.44b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, China Harmony Auto Holding would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for China Harmony Auto Holding

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.45 times and a disturbingly high net debt to EBITDA ratio of 10.4 hit our confidence in China Harmony Auto Holding like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that China Harmony Auto Holding achieved a positive EBIT of CN¥68m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Harmony Auto Holding'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, China Harmony Auto Holding burned a lot of cash. 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.

Our View

On the face of it, China Harmony Auto Holding's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Considering all the factors previously mentioned, we think that China Harmony Auto Holding really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for China Harmony Auto Holding that you should be aware of before investing here.

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.

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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.