Is China Electronics Huada Technology (HKG:85) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies China Electronics Huada Technology Company Limited (HKG:85) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for China Electronics Huada Technology

What Is China Electronics Huada Technology's Net Debt?

As you can see below, China Electronics Huada Technology had HK$615.7m of debt at December 2022, down from HK$672.7m a year prior. But on the other hand it also has HK$1.90b in cash, leading to a HK$1.29b net cash position.

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

We can see from the most recent balance sheet that China Electronics Huada Technology had liabilities of HK$2.02b falling due within a year, and liabilities of HK$387.8m due beyond that. Offsetting this, it had HK$1.90b in cash and HK$731.5m in receivables that were due within 12 months. So it actually has HK$232.4m more liquid assets than total liabilities.

This surplus suggests that China Electronics Huada Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, China Electronics Huada Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that China Electronics Huada Technology grew its EBIT by 418% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Electronics Huada Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Electronics Huada Technology 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. In the last three years, China Electronics Huada Technology's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Electronics Huada Technology has net cash of HK$1.29b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 418% over the last year. So is China Electronics Huada Technology's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for China Electronics Huada Technology (1 shouldn't be ignored!) 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.

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

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.