David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Hangzhou Heatwell Electric Heating Technology Co., Ltd. (SHSE:603075) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hangzhou Heatwell Electric Heating Technology's Debt?
As you can see below, Hangzhou Heatwell Electric Heating Technology had CN¥360.2m of debt at March 2024, down from CN¥540.7m a year prior. However, it does have CN¥948.1m in cash offsetting this, leading to net cash of CN¥587.9m.
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How Healthy Is Hangzhou Heatwell Electric Heating Technology's Balance Sheet?
According to the last reported balance sheet, Hangzhou Heatwell Electric Heating Technology had liabilities of CN¥777.6m due within 12 months, and liabilities of CN¥14.2m due beyond 12 months. On the other hand, it had cash of CN¥948.1m and CN¥541.4m worth of receivables due within a year. So it can boast CN¥697.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Hangzhou Heatwell Electric Heating Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hangzhou Heatwell Electric Heating Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Hangzhou Heatwell Electric Heating Technology grew its EBIT by 6.4% 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 it is Hangzhou Heatwell Electric Heating 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. While Hangzhou Heatwell Electric Heating Technology 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. In the last three years, Hangzhou Heatwell Electric Heating Technology's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Hangzhou Heatwell Electric Heating Technology has net cash of CN¥587.9m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 6.4% in the last twelve months. So we don't have any problem with Hangzhou Heatwell Electric Heating Technology's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hangzhou Heatwell Electric Heating Technology is showing 1 warning sign in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.