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These 4 Measures Indicate That Hollysys Automation Technologies (NASDAQ:HOLI) Is Using Debt Safely

Simply Wall St
·4-min read

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Hollysys Automation Technologies Ltd. (NASDAQ:HOLI) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hollysys Automation Technologies

How Much Debt Does Hollysys Automation Technologies Carry?

The image below, which you can click on for greater detail, shows that Hollysys Automation Technologies had debt of US$16.1m at the end of June 2020, a reduction from US$23.2m over a year. However, it does have US$613.7m in cash offsetting this, leading to net cash of US$597.6m.


A Look At Hollysys Automation Technologies's Liabilities

Zooming in on the latest balance sheet data, we can see that Hollysys Automation Technologies had liabilities of US$327.3m due within 12 months and liabilities of US$44.6m due beyond that. Offsetting this, it had US$613.7m in cash and US$486.0m in receivables that were due within 12 months. So it actually has US$727.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Hollysys Automation Technologies's balance sheet is just as strong as racists are weak. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Hollysys Automation Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Hollysys Automation Technologies's saving grace is its low debt levels, because its EBIT has tanked 22% in the last twelve months. 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 ultimately the future profitability of the business will decide if Hollysys Automation Technologies 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hollysys Automation Technologies 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. Happily for any shareholders, Hollysys Automation Technologies actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Hollysys Automation Technologies has US$597.6m in net cash and a strong balance sheet. The cherry on top was that in converted 102% of that EBIT to free cash flow, bringing in US$167m. So we don't think Hollysys Automation Technologies's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hollysys Automation Technologies is showing 3 warning signs in our investment analysis , you should know about...

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.

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. 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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