Is Shanxi Huaxiang Group (SHSE:603112) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Shanxi Huaxiang Group Co., Ltd. (SHSE:603112) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shanxi Huaxiang Group

What Is Shanxi Huaxiang Group's Net Debt?

As you can see below, at the end of September 2024, Shanxi Huaxiang Group had CN¥1.52b of debt, up from CN¥1.28b a year ago. Click the image for more detail. But on the other hand it also has CN¥1.67b in cash, leading to a CN¥153.3m net cash position.

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How Strong Is Shanxi Huaxiang Group's Balance Sheet?

We can see from the most recent balance sheet that Shanxi Huaxiang Group had liabilities of CN¥911.8m falling due within a year, and liabilities of CN¥1.68b due beyond that. On the other hand, it had cash of CN¥1.67b and CN¥1.30b worth of receivables due within a year. So it can boast CN¥375.1m more liquid assets than total liabilities.

This surplus suggests that Shanxi Huaxiang Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanxi Huaxiang Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Shanxi Huaxiang Group grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shanxi Huaxiang Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanxi Huaxiang Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Shanxi Huaxiang Group created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanxi Huaxiang Group has CN¥153.3m in net cash and a decent-looking balance sheet. And we liked the look of last year's 42% year-on-year EBIT growth. So is Shanxi Huaxiang Group's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shanxi Huaxiang Group's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.