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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Haitian International Holdings Limited (HKG:1882) does use debt in its business. But the more important question is: how much risk is that debt creating?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Haitian International Holdings
You can click the graphic below for the historical numbers, but it shows that as of December 2021 Haitian International Holdings had CN¥2.16b of debt, an increase on CN¥1.32b, over one year. But on the other hand it also has CN¥10.4b in cash, leading to a CN¥8.27b net cash position.
We can see from the most recent balance sheet that Haitian International Holdings had liabilities of CN¥9.34b falling due within a year, and liabilities of CN¥875.9m due beyond that. Offsetting these obligations, it had cash of CN¥10.4b as well as receivables valued at CN¥3.51b due within 12 months. So it actually has CN¥3.72b more liquid assets than total liabilities.
This surplus suggests that Haitian International Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Haitian International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that Haitian International Holdings has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Haitian International Holdings 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. While Haitian International Holdings 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. During the last three years, Haitian International Holdings generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Haitian International Holdings has net cash of CN¥8.27b, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in CN¥2.3b. So we don't think Haitian International Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Case in point: We've spotted 1 warning sign for Haitian International Holdings 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.
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