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. As with many other companies HMT (Xiamen) New Technical Materials Co., Ltd (SHSE:603306) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

What Is HMT (Xiamen) New Technical Materials's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 HMT (Xiamen) New Technical Materials had debt of CN¥798.4m, up from none in one year. However, its balance sheet shows it holds CN¥1.44b in cash, so it actually has CN¥642.5m net cash.

A Look At HMT (Xiamen) New Technical Materials' Liabilities

According to the last reported balance sheet, HMT (Xiamen) New Technical Materials had liabilities of CN¥242.4m due within 12 months, and liabilities of CN¥888.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.44b as well as receivables valued at CN¥973.3m due within 12 months. So it actually has CN¥1.28b more liquid assets than total liabilities.

It's good to see that HMT (Xiamen) New Technical Materials has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, HMT (Xiamen) New Technical Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that HMT (Xiamen) New Technical Materials has boosted its EBIT by 97%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HMT (Xiamen) New Technical Materials's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. While HMT (Xiamen) New Technical Materials 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, HMT (Xiamen) New Technical Materials recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that HMT (Xiamen) New Technical Materials has net cash of CN¥642.5m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 97% over the last year. So is HMT (Xiamen) New Technical Materials's debt a risk? It doesn't seem so to us. 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. Be aware that HMT (Xiamen) New Technical Materials is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.