We Think China Electronics Huada Technology (HKG:85) Can Manage Its Debt With Ease

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that China Electronics Huada Technology Company Limited (HKG:85) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out the opportunities and risks within the HK Semiconductor industry.

What Is China Electronics Huada Technology's Net Debt?

As you can see below, China Electronics Huada Technology had HK$643.1m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$1.04b in cash, so it actually has HK$398.4m net cash.

A Look At China Electronics Huada Technology's Liabilities

The latest balance sheet data shows that China Electronics Huada Technology had liabilities of HK$1.69b due within a year, and liabilities of HK$383.6m falling due after that. Offsetting this, it had HK$1.04b in cash and HK$1.10b in receivables that were due within 12 months. So it actually has HK$76.0m 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. 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 403% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Electronics Huada Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. Happily for any shareholders, China Electronics Huada Technology actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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$398.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 140% of that EBIT to free cash flow, bringing in HK$296m. 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. Be aware that China Electronics Huada Technology is showing 1 warning sign in our investment analysis , you should know about...

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.