Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Guangdong Huate Gas Co., Ltd (SHSE:688268) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Guangdong Huate Gas's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guangdong Huate Gas had CN¥870.0m of debt, an increase on CN¥253.0m, over one year. However, it does have CN¥999.3m in cash offsetting this, leading to net cash of CN¥129.3m.
How Healthy Is Guangdong Huate Gas' Balance Sheet?
According to the last reported balance sheet, Guangdong Huate Gas had liabilities of CN¥428.5m due within 12 months, and liabilities of CN¥887.0m due beyond 12 months. Offsetting this, it had CN¥999.3m in cash and CN¥444.4m in receivables that were due within 12 months. So it actually has CN¥128.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Guangdong Huate Gas could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guangdong Huate Gas boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Guangdong Huate Gas's EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Guangdong Huate Gas 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Guangdong Huate Gas 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, Guangdong Huate Gas 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 Guangdong Huate Gas has CN¥129.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Guangdong Huate Gas's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Guangdong Huate Gas that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.