Shanghai Research Institute of Building Sciences Group (SHSE:603153) Seems To Use Debt Quite Sensibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shanghai Research Institute of Building Sciences Group Co., Ltd. (SHSE:603153) 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Research Institute of Building Sciences Group

How Much Debt Does Shanghai Research Institute of Building Sciences Group Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Shanghai Research Institute of Building Sciences Group had debt of CN¥17.5m, up from CN¥11.5m in one year. However, its balance sheet shows it holds CN¥1.55b in cash, so it actually has CN¥1.53b net cash.

How Healthy Is Shanghai Research Institute of Building Sciences Group's Balance Sheet?

The latest balance sheet data shows that Shanghai Research Institute of Building Sciences Group had liabilities of CN¥874.9m due within a year, and liabilities of CN¥103.7m falling due after that. On the other hand, it had cash of CN¥1.55b and CN¥1.41b worth of receivables due within a year. So it can boast CN¥1.98b more liquid assets than total liabilities.

This excess liquidity suggests that Shanghai Research Institute of Building Sciences Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Shanghai Research Institute of Building Sciences Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Shanghai Research Institute of Building Sciences Group has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Research Institute of Building Sciences 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shanghai Research Institute of Building Sciences Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Shanghai Research Institute of Building Sciences Group recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Research Institute of Building Sciences Group has net cash of CN¥1.53b, as well as more liquid assets than liabilities. So we are not troubled with Shanghai Research Institute of Building Sciences Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shanghai Research Institute of Building Sciences Group has 3 warning signs (and 1 which is concerning) we think 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.

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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.