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.' 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. We can see that Hundsun Technologies Inc. (SHSE:600570) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Hundsun Technologies
What Is Hundsun Technologies's Net Debt?
As you can see below, Hundsun Technologies had CN¥526.7m of debt at September 2022, down from CN¥669.8m a year prior. However, it does have CN¥2.82b in cash offsetting this, leading to net cash of CN¥2.29b.
A Look At Hundsun Technologies' Liabilities
Zooming in on the latest balance sheet data, we can see that Hundsun Technologies had liabilities of CN¥4.71b due within 12 months and liabilities of CN¥373.4m due beyond that. Offsetting these obligations, it had cash of CN¥2.82b as well as receivables valued at CN¥973.5m due within 12 months. So its liabilities total CN¥1.29b more than the combination of its cash and short-term receivables.
This state of affairs indicates that Hundsun Technologies' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥85.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Hundsun Technologies 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 Hundsun Technologies if management cannot prevent a repeat of the 22% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hundsun Technologies 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 company can only pay off debt with cold hard cash, not accounting profits. Hundsun Technologies 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, Hundsun Technologies's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about Hundsun Technologies's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.29b. So we don't have any problem with Hundsun Technologies's use of debt. 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. For example - Hundsun Technologies has 1 warning sign we think 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.