Hon Hai Precision Industry (TWSE:2317) Has A Pretty 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Hon Hai Precision Industry Co., Ltd. (TWSE:2317) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hon Hai Precision Industry

How Much Debt Does Hon Hai Precision Industry Carry?

As you can see below, Hon Hai Precision Industry had NT$848.2b of debt at June 2024, down from NT$915.4b a year prior. However, its balance sheet shows it holds NT$1.26t in cash, so it actually has NT$408.0b net cash.

How Strong Is Hon Hai Precision Industry's Balance Sheet?

We can see from the most recent balance sheet that Hon Hai Precision Industry had liabilities of NT$1.87t falling due within a year, and liabilities of NT$373.7b due beyond that. Offsetting these obligations, it had cash of NT$1.26t as well as receivables valued at NT$921.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$67.4b.

Since publicly traded Hon Hai Precision Industry shares are worth a very impressive total of NT$2.56t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Hon Hai Precision Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Hon Hai Precision Industry grew its EBIT by 7.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hon Hai Precision Industry can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hon Hai Precision Industry 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, Hon Hai Precision Industry recorded free cash flow of 48% 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 look at a company's total liabilities, it is very reassuring that Hon Hai Precision Industry has NT$408.0b in net cash. And it also grew its EBIT by 7.4% over the last year. So we don't have any problem with Hon Hai Precision Industry's use of debt. 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 - Hon Hai Precision Industry has 1 warning sign we think you should be aware of.

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.