We Think Shanghai Yanpu Metal ProductsLtd (SHSE:605128) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Shanghai Yanpu Metal Products Co.,Ltd (SHSE:605128) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shanghai Yanpu Metal ProductsLtd

How Much Debt Does Shanghai Yanpu Metal ProductsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Yanpu Metal ProductsLtd had CN¥487.0m of debt, an increase on CN¥328.5m, over one year. However, because it has a cash reserve of CN¥161.6m, its net debt is less, at about CN¥325.4m.

How Strong Is Shanghai Yanpu Metal ProductsLtd's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Yanpu Metal ProductsLtd had liabilities of CN¥860.7m falling due within a year, and liabilities of CN¥356.8m due beyond that. On the other hand, it had cash of CN¥161.6m and CN¥926.5m worth of receivables due within a year. So it has liabilities totalling CN¥129.5m more than its cash and near-term receivables, combined.

Since publicly traded Shanghai Yanpu Metal ProductsLtd shares are worth a total of CN¥4.15b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 1.4 times EBITDA, Shanghai Yanpu Metal ProductsLtd is arguably pretty conservatively geared. And it boasts interest cover of 8.1 times, which is more than adequate. Even more impressive was the fact that Shanghai Yanpu Metal ProductsLtd grew its EBIT by 113% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Yanpu Metal ProductsLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shanghai Yanpu Metal ProductsLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Shanghai Yanpu Metal ProductsLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its EBIT growth rate. Considering this range of data points, we think Shanghai Yanpu Metal ProductsLtd is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shanghai Yanpu Metal ProductsLtd you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.