Does Hua Hong Semiconductor (HKG:1347) Have A Healthy Balance Sheet?

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. As with many other companies Hua Hong Semiconductor Limited (HKG:1347) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Hua Hong Semiconductor

What Is Hua Hong Semiconductor's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Hua Hong Semiconductor had debt of US$1.78b, up from US$1.34b in one year. But on the other hand it also has US$1.98b in cash, leading to a US$206.3m net cash position.

How Healthy Is Hua Hong Semiconductor's Balance Sheet?

The latest balance sheet data shows that Hua Hong Semiconductor had liabilities of US$1.40b due within a year, and liabilities of US$1.40b falling due after that. Offsetting this, it had US$1.98b in cash and US$251.3m in receivables that were due within 12 months. So it has liabilities totalling US$565.2m more than its cash and near-term receivables, combined.

Since publicly traded Hua Hong Semiconductor shares are worth a total of US$5.70b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Hua Hong Semiconductor also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Hua Hong Semiconductor grew its EBIT by 361% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hua Hong Semiconductor'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. Hua Hong Semiconductor 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 two years, Hua Hong Semiconductor 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

We could understand if investors are concerned about Hua Hong Semiconductor's liabilities, but we can be reassured by the fact it has has net cash of US$206.3m. And it impressed us with its EBIT growth of 361% over the last year. So we don't have any problem with Hua Hong Semiconductor's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hua Hong Semiconductor's earnings per share history for free.

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.