Shanghai Waigaoqiao Free Trade Zone Group (SHSE:600648) Has No Shortage Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Shanghai Waigaoqiao Free Trade Zone Group Co., Ltd. (SHSE:600648) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shanghai Waigaoqiao Free Trade Zone Group

What Is Shanghai Waigaoqiao Free Trade Zone Group's Debt?

As you can see below, at the end of June 2024, Shanghai Waigaoqiao Free Trade Zone Group had CN¥21.6b of debt, up from CN¥18.5b a year ago. Click the image for more detail. On the flip side, it has CN¥4.35b in cash leading to net debt of about CN¥17.2b.

A Look At Shanghai Waigaoqiao Free Trade Zone Group's Liabilities

We can see from the most recent balance sheet that Shanghai Waigaoqiao Free Trade Zone Group had liabilities of CN¥19.7b falling due within a year, and liabilities of CN¥11.2b due beyond that. Offsetting this, it had CN¥4.35b in cash and CN¥1.33b in receivables that were due within 12 months. So its liabilities total CN¥25.3b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥9.56b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Shanghai Waigaoqiao Free Trade Zone Group would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shanghai Waigaoqiao Free Trade Zone Group shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 2.4 times the interest expense. The debt burden here is substantial. Worse, Shanghai Waigaoqiao Free Trade Zone Group's EBIT was down 32% over the last year. 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shanghai Waigaoqiao Free Trade Zone 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.

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. During the last three years, Shanghai Waigaoqiao Free Trade Zone Group burned a lot of cash. 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

On the face of it, Shanghai Waigaoqiao Free Trade Zone Group's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its net debt to EBITDA fails to inspire much confidence. It looks to us like Shanghai Waigaoqiao Free Trade Zone Group carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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. Case in point: We've spotted 4 warning signs for Shanghai Waigaoqiao Free Trade Zone Group you should be aware of, and 1 of them shouldn't be ignored.

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.