Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shanghai Huace Navigation Technology Ltd (SZSE:300627) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Shanghai Huace Navigation Technology's Debt?
The image below, which you can click on for greater detail, shows that Shanghai Huace Navigation Technology had debt of CN¥210.3m at the end of March 2024, a reduction from CN¥324.4m over a year. However, its balance sheet shows it holds CN¥1.26b in cash, so it actually has CN¥1.05b net cash.
How Strong Is Shanghai Huace Navigation Technology's Balance Sheet?
We can see from the most recent balance sheet that Shanghai Huace Navigation Technology had liabilities of CN¥920.4m falling due within a year, and liabilities of CN¥190.4m due beyond that. On the other hand, it had cash of CN¥1.26b and CN¥1.09b worth of receivables due within a year. So it actually has CN¥1.24b more liquid assets than total liabilities.
This short term liquidity is a sign that Shanghai Huace Navigation Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Huace Navigation Technology 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 Shanghai Huace Navigation Technology has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Huace Navigation Technology'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Huace Navigation 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. Looking at the most recent three years, Shanghai Huace Navigation Technology recorded free cash flow of 40% of its EBIT, which is weaker 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 Shanghai Huace Navigation Technology has CN¥1.05b in net cash and a decent-looking balance sheet. And we liked the look of last year's 47% year-on-year EBIT growth. So we don't think Shanghai Huace Navigation Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Shanghai Huace Navigation Technology that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
