Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Shanghai Haohai Biological Technology Co., Ltd. (HKG:6826) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Shanghai Haohai Biological Technology
What Is Shanghai Haohai Biological Technology's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Shanghai Haohai Biological Technology had debt of CN¥390.2m, up from CN¥118.3m in one year. But on the other hand it also has CN¥2.73b in cash, leading to a CN¥2.34b net cash position.
A Look At Shanghai Haohai Biological Technology's Liabilities
According to the last reported balance sheet, Shanghai Haohai Biological Technology had liabilities of CN¥689.8m due within 12 months, and liabilities of CN¥381.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.73b as well as receivables valued at CN¥383.1m due within 12 months. So it actually has CN¥2.04b more liquid assets than total liabilities.
This surplus suggests that Shanghai Haohai Biological Technology is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Shanghai Haohai Biological Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Shanghai Haohai Biological Technology has boosted its EBIT by 70%, thus reducing the spectre of future debt repayments. 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 company can only pay off debt with cold hard cash, not accounting profits. 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 34% 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¥2.34b in net cash and a decent-looking balance sheet. And we liked the look of last year's 70% year-on-year EBIT growth. So we don't think Shanghai Haohai Biological Technology's use of debt is risky. Another factor that would give us confidence in Shanghai Haohai Biological Technology would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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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