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 Shanghai Haohai Biological Technology Co., Ltd. (HKG:6826) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Shanghai Haohai Biological Technology's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2023 Shanghai Haohai Biological Technology had debt of CN¥353.8m, up from CN¥57.0m in one year. However, its balance sheet shows it holds CN¥2.76b in cash, so it actually has CN¥2.41b net cash.
How Strong Is Shanghai Haohai Biological Technology's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shanghai Haohai Biological Technology had liabilities of CN¥716.0m due within 12 months and liabilities of CN¥372.3m due beyond that. Offsetting these obligations, it had cash of CN¥2.76b as well as receivables valued at CN¥375.4m due within 12 months. So it actually has CN¥2.05b more liquid assets than total liabilities.
This surplus suggests that Shanghai Haohai Biological Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Haohai Biological Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Shanghai Haohai Biological Technology grew its EBIT by 132% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shanghai Haohai Biological Technology 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Haohai Biological Technology 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, Shanghai Haohai Biological Technology'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.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shanghai Haohai Biological Technology has CN¥2.41b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 132% over the last year. So is Shanghai Haohai Biological Technology's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Shanghai Haohai Biological Technology, you may well want to click here to check an interactive graph of its earnings per share history.
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.