Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Hengtong Logistics Co., Ltd. (SHSE:603223) does carry debt. But the more important question is: how much risk is that debt creating?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Hengtong Logistics's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Hengtong Logistics had debt of CN¥547.6m, up from CN¥512.9m in one year. However, its balance sheet shows it holds CN¥1.66b in cash, so it actually has CN¥1.11b net cash.
How Healthy Is Hengtong Logistics' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hengtong Logistics had liabilities of CN¥783.1m due within 12 months and liabilities of CN¥391.6m due beyond that. On the other hand, it had cash of CN¥1.66b and CN¥297.4m worth of receivables due within a year. So it actually has CN¥779.6m more liquid assets than total liabilities.
It's good to see that Hengtong Logistics 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, Hengtong Logistics boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Hengtong Logistics grew its EBIT by 118% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hengtong Logistics'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hengtong Logistics 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. Over the last three years, Hengtong Logistics saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Hengtong Logistics has CN¥1.11b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 118% over the last year. So we don't think Hengtong Logistics's use of debt is risky. 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 Hengtong Logistics (of which 1 is a bit concerning!) 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.
