Does Hengxin Technology (HKG:1085) Have A Healthy Balance Sheet?

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 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. Importantly, Hengxin Technology Ltd. (HKG:1085) does carry debt. But is this debt a concern to shareholders?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hengxin Technology

How Much Debt Does Hengxin Technology Carry?

The image below, which you can click on for greater detail, shows that Hengxin Technology had debt of CN¥292.1m at the end of June 2021, a reduction from CN¥327.8m over a year. However, its balance sheet shows it holds CN¥1.22b in cash, so it actually has CN¥928.3m net cash.

How Strong Is Hengxin Technology's Balance Sheet?

The latest balance sheet data shows that Hengxin Technology had liabilities of CN¥492.7m due within a year, and liabilities of CN¥13.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.22b as well as receivables valued at CN¥663.0m due within 12 months. So it actually has CN¥1.38b more liquid assets than total liabilities.

This luscious liquidity implies that Hengxin Technology's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Hengxin Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Hengxin Technology's load is not too heavy, because its EBIT was down 50% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hengxin 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 Hengxin 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. Over the last three years, Hengxin Technology actually produced more free cash flow than EBIT. 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, the bottom line is that Hengxin Technology has net cash of CN¥928.3m and plenty of liquid assets. The cherry on top was that in converted 243% of that EBIT to free cash flow, bringing in CN¥204m. So we don't think Hengxin Technology's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hengxin Technology (of which 1 can't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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