Hua Hong Semiconductor (HKG:1347) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Hua Hong Semiconductor Limited (HKG:1347) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Hua Hong Semiconductor

How Much Debt Does Hua Hong Semiconductor Carry?

As you can see below, at the end of September 2023, Hua Hong Semiconductor had US$1.93b of debt, up from US$1.78b a year ago. Click the image for more detail. But it also has US$4.99b in cash to offset that, meaning it has US$3.06b net cash.

How Healthy Is Hua Hong Semiconductor's Balance Sheet?

We can see from the most recent balance sheet that Hua Hong Semiconductor had liabilities of US$851.0m falling due within a year, and liabilities of US$1.79b due beyond that. Offsetting these obligations, it had cash of US$4.99b as well as receivables valued at US$338.4m due within 12 months. So it can boast US$2.69b more liquid assets than total liabilities.

This excess liquidity is a great indication that Hua Hong Semiconductor's 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. Succinctly put, Hua Hong Semiconductor boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Hua Hong Semiconductor's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hua Hong Semiconductor has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Hua Hong Semiconductor burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hua Hong Semiconductor has US$3.06b in net cash and a decent-looking balance sheet. So we are not troubled with Hua Hong Semiconductor's debt use. 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. We've identified 2 warning signs with Hua Hong Semiconductor (at least 1 which is a bit concerning) , 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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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.