Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Above all, Shanghai Haohai Biological Technology Co., Ltd. (HKG: 6826) carries a debt. But does this debt worry shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest analysis for Shanghai Haohai Biological Technology
What is the net debt of Shanghai Haohai Biological Technology?
As you can see below, Shanghai Haohai Biological Technology had a debt of CN 37.7 million in June 2021, compared to CN 64.9 million the previous year. However, it has CN ¥ 3.14b in cash offsetting this, leading to net cash of CN ¥ 3.10b.
How strong is Shanghai Haohai Biological Technology’s balance sheet?
The latest balance sheet data shows that Shanghai Haohai Biological Technology had debts of CNS 512.1 million due within one year, and CN debts of CN 140.5 million falling due after that. In return, he had CN 3.14 billion in cash and CN 408.2 million in receivables due within 12 months. So, it can boast of having more CN ¥ 2.90b of liquid assets than total Liabilities.
This short-term liquidity is a sign that Shanghai Haohai Biological Technology could probably repay its debt easily, as its balance sheet is far from tight. Put simply, the fact that Shanghai Haohai Biological Technology has more cash than debt is arguably a good indication that it can safely manage its debt.
Best of all, Shanghai Haohai Biological Technology increased its EBIT by 852% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in the years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Shanghai Haohai Biological Technology can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. While Shanghai Haohai Biological Technology has net cash on its balance sheet, it’s still worth examining its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it is. this cash balance is built (or eroded). Over the past three years, Shanghai Haohai Biological Technology has recorded free cash flow of 29% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
In summary
While it is always a good idea to investigate a company’s debt, in this case Shanghai Haohai Biological Technology has a net cash position of 3.10 billion yuan and a decent balance sheet. And we liked the appearance of the 852% year-over-year EBIT growth from last year. So is Shanghai Haohai Biological Technology’s debt a risk? It does not seem to us. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example – Shanghai Haohai Biological Technology has 1 warning sign we think you should be aware.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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