Is Sichuan Road & Bridge GroupLtd (SHSE:600039) Using Too Much Debt?

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, Sichuan Road & Bridge Group Co.,Ltd (SHSE:600039) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sichuan Road & Bridge GroupLtd

What Is Sichuan Road & Bridge GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sichuan Road & Bridge GroupLtd had debt of CN¥87.9b, up from CN¥72.6b in one year. However, it does have CN¥17.9b in cash offsetting this, leading to net debt of about CN¥70.0b.

A Look At Sichuan Road & Bridge GroupLtd's Liabilities

We can see from the most recent balance sheet that Sichuan Road & Bridge GroupLtd had liabilities of CN¥124.5b falling due within a year, and liabilities of CN¥75.0b due beyond that. On the other hand, it had cash of CN¥17.9b and CN¥107.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥73.7b.

Given this deficit is actually higher than the company's market capitalization of CN¥63.6b, we think shareholders really should watch Sichuan Road & Bridge GroupLtd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 5.3, it's fair to say Sichuan Road & Bridge GroupLtd does have a significant amount of debt. However, its interest coverage of 3.9 is reasonably strong, which is a good sign. Even worse, Sichuan Road & Bridge GroupLtd saw its EBIT tank 35% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sichuan Road & Bridge GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Sichuan Road & Bridge GroupLtd actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Sichuan Road & Bridge GroupLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its level of total liabilities fails to inspire much confidence. After considering the datapoints discussed, we think Sichuan Road & Bridge GroupLtd has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 2 warning signs for Sichuan Road & Bridge GroupLtd (of which 1 is a bit unpleasant!) 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.

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.