The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hwatsing Technology Co., Ltd. (SHSE:688120) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. 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. 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.
What Is Hwatsing Technology's Net Debt?
As you can see below, at the end of March 2024, Hwatsing Technology had CN¥608.4m of debt, up from CN¥221.2m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥4.59b in cash, so it actually has CN¥3.98b net cash.
How Strong Is Hwatsing Technology's Balance Sheet?
According to the last reported balance sheet, Hwatsing Technology had liabilities of CN¥2.90b due within 12 months, and liabilities of CN¥1.07b due beyond 12 months. Offsetting this, it had CN¥4.59b in cash and CN¥701.4m in receivables that were due within 12 months. So it actually has CN¥1.31b more liquid assets than total liabilities.
This short term liquidity is a sign that Hwatsing Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hwatsing Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
Also positive, Hwatsing Technology grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. 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 Hwatsing Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hwatsing 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. In the last three years, Hwatsing Technology's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While it is always sensible to investigate a company's debt, in this case Hwatsing Technology has CN¥3.98b in net cash and a decent-looking balance sheet. And we liked the look of last year's 30% year-on-year EBIT growth. So is Hwatsing Technology's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Hwatsing Technology that 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.