Is Shanghai Highly (Group) (SHSE:600619) A Risky Investment?

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 Shanghai Highly (Group) Co., Ltd. (SHSE:600619) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shanghai Highly (Group)

What Is Shanghai Highly (Group)'s Debt?

As you can see below, Shanghai Highly (Group) had CN¥4.25b of debt at September 2024, down from CN¥4.83b a year prior. However, because it has a cash reserve of CN¥4.21b, its net debt is less, at about CN¥39.3m.

How Healthy Is Shanghai Highly (Group)'s Balance Sheet?

The latest balance sheet data shows that Shanghai Highly (Group) had liabilities of CN¥13.0b due within a year, and liabilities of CN¥1.43b falling due after that. Offsetting this, it had CN¥4.21b in cash and CN¥6.09b in receivables that were due within 12 months. So it has liabilities totalling CN¥4.12b more than its cash and near-term receivables, combined.

Shanghai Highly (Group) has a market capitalization of CN¥9.43b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Carrying virtually no net debt, Shanghai Highly (Group) has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shanghai Highly (Group) has a net debt to EBITDA ratio of 0.051, suggesting a very conservative balance sheet. But strangely, EBIT was only 2.3 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Notably, Shanghai Highly (Group) made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥174m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shanghai Highly (Group) will need earnings to service that debt. 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Shanghai Highly (Group) actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Both Shanghai Highly (Group)'s ability to to convert EBIT to free cash flow and its net debt to EBITDA gave us comfort that it can handle its debt. But truth be told its interest cover had us nibbling our nails. Considering this range of data points, we think Shanghai Highly (Group) is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Shanghai Highly (Group) (at least 2 which are a bit concerning) , 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.

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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.