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 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. Importantly, Hunan Haili Chemical Industry Co., Ltd. (SHSE:600731) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
See our latest analysis for Hunan Haili Chemical Industry
How Much Debt Does Hunan Haili Chemical Industry Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2023 Hunan Haili Chemical Industry had CN¥658.8m of debt, an increase on CN¥520.0m, over one year. However, it does have CN¥1.41b in cash offsetting this, leading to net cash of CN¥748.4m.
A Look At Hunan Haili Chemical Industry's Liabilities
The latest balance sheet data shows that Hunan Haili Chemical Industry had liabilities of CN¥690.1m due within a year, and liabilities of CN¥868.3m falling due after that. Offsetting these obligations, it had cash of CN¥1.41b as well as receivables valued at CN¥711.0m due within 12 months. So it actually has CN¥559.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Hunan Haili Chemical Industry could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hunan Haili Chemical Industry boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Hunan Haili Chemical Industry grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hunan Haili Chemical Industry will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Hunan Haili Chemical Industry 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. Considering the last three years, Hunan Haili Chemical Industry actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing Up
While it is always sensible to investigate a company's debt, in this case Hunan Haili Chemical Industry has CN¥748.4m in net cash and a decent-looking balance sheet. And we liked the look of last year's 39% year-on-year EBIT growth. So is Hunan Haili Chemical Industry's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hunan Haili Chemical Industry is showing 1 warning sign in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
