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. We can see that Hengxin Technology Ltd. (HKG:1085) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
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What Is Hengxin Technology's Debt?
The image below, which you can click on for greater detail, shows that at December 2021 Hengxin Technology had debt of CN¥330.3m, up from CN¥278.4m in one year. But on the other hand it also has CN¥1.05b in cash, leading to a CN¥722.6m net cash position.
A Look At Hengxin Technology's Liabilities
Zooming in on the latest balance sheet data, we can see that Hengxin Technology had liabilities of CN¥677.5m due within 12 months and liabilities of CN¥12.8m due beyond that. Offsetting this, it had CN¥1.05b in cash and CN¥955.5m in receivables that were due within 12 months. So it actually has CN¥1.32b more liquid assets than total liabilities.
This excess liquidity is a great indication that Hengxin Technology's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Hengxin Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Hengxin Technology grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hengxin 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, a company can only pay off debt with cold hard cash, not accounting profits. Hengxin 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. Looking at the most recent three years, Hengxin Technology recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case Hengxin Technology has CN¥722.6m in net cash and a strong balance sheet. And we liked the look of last year's 46% year-on-year EBIT growth. So we don't think Hengxin Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hengxin Technology is showing 2 warning signs in our investment analysis , 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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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.
About SEHK:1085
Hengxin Technology
An investment holding company, engages in the research, design, manufacture, development, and sale of integrated antennas and feeder cables for mobile communications in the People’s Republic of China.
Excellent balance sheet and good value.