Shanghai Moons' Electric (SHSE:603728) Takes On Some Risk With Its Use Of 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.' 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. Importantly, Shanghai Moons' Electric Co., Ltd. (SHSE:603728) does carry debt. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shanghai Moons' Electric

What Is Shanghai Moons' Electric's Net Debt?

The image below, which you can click on for greater detail, shows that Shanghai Moons' Electric had debt of CN¥262.7m at the end of March 2024, a reduction from CN¥328.9m over a year. But on the other hand it also has CN¥569.5m in cash, leading to a CN¥306.8m net cash position.

A Look At Shanghai Moons' Electric's Liabilities

We can see from the most recent balance sheet that Shanghai Moons' Electric had liabilities of CN¥890.2m falling due within a year, and liabilities of CN¥93.4m due beyond that. Offsetting these obligations, it had cash of CN¥569.5m as well as receivables valued at CN¥860.7m due within 12 months. So it can boast CN¥446.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Moons' Electric could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Moons' Electric boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Shanghai Moons' Electric if management cannot prevent a repeat of the 50% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Moons' Electric can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shanghai Moons' Electric 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. Over the last three years, Shanghai Moons' Electric saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Moons' Electric has net cash of CN¥306.8m, as well as more liquid assets than liabilities. So while Shanghai Moons' Electric does not have a great balance sheet, it's certainly not too bad. 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, we've discovered 1 warning sign for Shanghai Moons' Electric that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com