Here's Why HengTen Networks Group (HKG:136) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 HengTen Networks Group Limited (HKG:136) does use debt in its business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for HengTen Networks Group

What Is HengTen Networks Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 HengTen Networks Group had CN¥52.6m of debt, an increase on CN¥50.8, over one year. But on the other hand it also has CN¥1.17b in cash, leading to a CN¥1.12b net cash position.

A Look At HengTen Networks Group's Liabilities

According to the last reported balance sheet, HengTen Networks Group had liabilities of CN¥225.7m due within 12 months, and liabilities of CN¥41.5m due beyond 12 months. On the other hand, it had cash of CN¥1.17b and CN¥65.0m worth of receivables due within a year. So it actually has CN¥967.2m more liquid assets than total liabilities.

This short term liquidity is a sign that HengTen Networks Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, HengTen Networks Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that HengTen Networks Group's load is not too heavy, because its EBIT was down 68% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is HengTen Networks Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. HengTen Networks Group 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, HengTen Networks Group generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HengTen Networks Group has net cash of CN¥1.12b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥13m, being 91% of its EBIT. So we are not troubled with HengTen Networks Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with HengTen Networks Group , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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