Is Hua Hong Semiconductor (HKG:1347) Using Debt In A Risky Way?

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.' 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?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hua Hong Semiconductor

How Much Debt Does Hua Hong Semiconductor Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Hua Hong Semiconductor had US$2.23b of debt, an increase on US$1.91b, over one year. However, its balance sheet shows it holds US$6.11b in cash, so it actually has US$3.88b net cash.

How Strong Is Hua Hong Semiconductor's Balance Sheet?

The latest balance sheet data shows that Hua Hong Semiconductor had liabilities of US$967.2m due within a year, and liabilities of US$2.01b falling due after that. Offsetting these obligations, it had cash of US$6.11b as well as receivables valued at US$321.8m due within 12 months. So it can boast US$3.45b 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. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Hua Hong Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hua Hong Semiconductor can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Hua Hong Semiconductor had a loss before interest and tax, and actually shrunk its revenue by 16%, to US$2.1b. We would much prefer see growth.

So How Risky Is Hua Hong Semiconductor?

While Hua Hong Semiconductor lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of US$160m. 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. 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 , 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com