China Electronics Huada Technology (HKG:85) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Electronics Huada Technology Company Limited (HKG:85) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 China Electronics Huada Technology

What Is China Electronics Huada Technology's Net Debt?

The image below, which you can click on for greater detail, shows that China Electronics Huada Technology had debt of HK$672.7m at the end of December 2021, a reduction from HK$712.3m over a year. However, its balance sheet shows it holds HK$1.01b in cash, so it actually has HK$333.1m net cash.

How Strong Is China Electronics Huada Technology's Balance Sheet?

According to the last reported balance sheet, China Electronics Huada Technology had liabilities of HK$1.52b due within 12 months, and liabilities of HK$49.9m due beyond 12 months. Offsetting these obligations, it had cash of HK$1.01b as well as receivables valued at HK$747.7m due within 12 months. So it actually has HK$186.5m more liquid assets than total liabilities.

This short term liquidity is a sign that China Electronics Huada Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that China Electronics Huada Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that China Electronics Huada Technology has boosted its EBIT by 72%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is China Electronics Huada Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. China Electronics Huada Technology 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 three years, China Electronics Huada Technology recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case China Electronics Huada Technology has HK$333.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in HK$48m. So we don't think China Electronics Huada Technology's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for China Electronics Huada Technology (1 is concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.