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. As with many other companies Guangdong Hongtu Technology (holdings) Co.,Ltd. (SZSE:002101) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Guangdong Hongtu Technology (holdings)Ltd Carry?
As you can see below, Guangdong Hongtu Technology (holdings)Ltd had CN¥751.9m of debt at September 2024, down from CN¥1.12b a year prior. However, it does have CN¥2.37b in cash offsetting this, leading to net cash of CN¥1.62b.
How Strong Is Guangdong Hongtu Technology (holdings)Ltd's Balance Sheet?
We can see from the most recent balance sheet that Guangdong Hongtu Technology (holdings)Ltd had liabilities of CN¥4.77b falling due within a year, and liabilities of CN¥895.8m due beyond that. Offsetting this, it had CN¥2.37b in cash and CN¥2.90b in receivables that were due within 12 months. So its liabilities total CN¥389.6m more than the combination of its cash and short-term receivables.
Of course, Guangdong Hongtu Technology (holdings)Ltd has a market capitalization of CN¥7.55b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Guangdong Hongtu Technology (holdings)Ltd also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Guangdong Hongtu Technology (holdings)Ltd if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Guangdong Hongtu Technology (holdings)Ltd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Guangdong Hongtu Technology (holdings)Ltd 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. Looking at the most recent three years, Guangdong Hongtu Technology (holdings)Ltd recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Guangdong Hongtu Technology (holdings)Ltd has CN¥1.62b in net cash. So we don't have any problem with Guangdong Hongtu Technology (holdings)Ltd'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. For instance, we've identified 1 warning sign for Guangdong Hongtu Technology (holdings)Ltd that you should be aware of.
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.
