Warren Buffett famously said, '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 can see that China Leon Inspection Holding Limited (HKG:1586) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for China Leon Inspection Holding
How Much Debt Does China Leon Inspection Holding Carry?
You can click the graphic below for the historical numbers, but it shows that China Leon Inspection Holding had HK$54.5m of debt in June 2024, down from HK$78.1m, one year before. However, its balance sheet shows it holds HK$236.9m in cash, so it actually has HK$182.4m net cash.
How Healthy Is China Leon Inspection Holding's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Leon Inspection Holding had liabilities of HK$203.3m due within 12 months and liabilities of HK$39.1m due beyond that. Offsetting this, it had HK$236.9m in cash and HK$225.5m in receivables that were due within 12 months. So it can boast HK$220.1m more liquid assets than total liabilities.
It's good to see that China Leon Inspection Holding has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that China Leon Inspection Holding has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that China Leon Inspection Holding has increased its EBIT by 7.4% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is China Leon Inspection Holding's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. China Leon Inspection Holding may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, China Leon Inspection Holding produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that China Leon Inspection Holding has net cash of HK$182.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$94m, being 77% of its EBIT. So we don't think China Leon Inspection Holding's use of debt is risky. Another factor that would give us confidence in China Leon Inspection Holding 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.