Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hailir Pesticides and Chemicals Group Co.,Ltd. (SHSE:603639) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Hailir Pesticides and Chemicals GroupLtd
What Is Hailir Pesticides and Chemicals GroupLtd's Debt?
As you can see below, Hailir Pesticides and Chemicals GroupLtd had CN¥618.2m of debt at June 2023, down from CN¥700.0m a year prior. However, its balance sheet shows it holds CN¥702.8m in cash, so it actually has CN¥84.6m net cash.
A Look At Hailir Pesticides and Chemicals GroupLtd's Liabilities
Zooming in on the latest balance sheet data, we can see that Hailir Pesticides and Chemicals GroupLtd had liabilities of CN¥2.43b due within 12 months and liabilities of CN¥316.9m due beyond that. Offsetting this, it had CN¥702.8m in cash and CN¥1.35b in receivables that were due within 12 months. So it has liabilities totalling CN¥694.4m more than its cash and near-term receivables, combined.
Given Hailir Pesticides and Chemicals GroupLtd has a market capitalization of CN¥5.56b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Hailir Pesticides and Chemicals GroupLtd 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 Hailir Pesticides and Chemicals GroupLtd if management cannot prevent a repeat of the 22% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hailir Pesticides and Chemicals GroupLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Hailir Pesticides and Chemicals GroupLtd 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, Hailir Pesticides and Chemicals GroupLtd created free cash flow amounting to 10% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing Up
While Hailir Pesticides and Chemicals GroupLtd does have more liabilities than liquid assets, it also has net cash of CN¥84.6m. So while Hailir Pesticides and Chemicals GroupLtd does not have a great balance sheet, it's certainly not too bad. 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. Case in point: We've spotted 1 warning sign for Hailir Pesticides and Chemicals GroupLtd you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.