Hengxin Technology (HKG:1085) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Hengxin Technology Ltd. (HKG:1085) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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¥278.4m at the end of December 2020, a reduction from CN¥310.0m over a year. However, it does have CN¥1.36b in cash offsetting this, leading to net cash of CN¥1.08b.

How Strong Is Hengxin Technology's Balance Sheet?

According to the last reported balance sheet, Hengxin Technology had liabilities of CN¥481.0m due within 12 months, and liabilities of CN¥14.4m due beyond 12 months. Offsetting this, it had CN¥1.36b in cash and CN¥549.5m in receivables that were due within 12 months. So it actually has CN¥1.41b more liquid assets than total liabilities.

This luscious liquidity implies that Hengxin Technology's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. 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 60% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is Hengxin Technology's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Hengxin Technology has CN¥1.08b in net cash and a strong balance sheet. And it impressed us with free cash flow of CN¥359m, being 183% of its EBIT. So is Hengxin 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. 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 makes us a bit uncomfortable!) you should know about.

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.

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