Is China International Marine Containers (Group) (SZSE:000039) Using Too Much 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.' 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 China International Marine Containers (Group) Co., Ltd. (SZSE:000039) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 China International Marine Containers (Group)

What Is China International Marine Containers (Group)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China International Marine Containers (Group) had CN¥47.0b of debt, an increase on CN¥37.0b, over one year. However, it does have CN¥26.3b in cash offsetting this, leading to net debt of about CN¥20.7b.

A Look At China International Marine Containers (Group)'s Liabilities

The latest balance sheet data shows that China International Marine Containers (Group) had liabilities of CN¥85.0b due within a year, and liabilities of CN¥28.6b falling due after that. Offsetting these obligations, it had cash of CN¥26.3b as well as receivables valued at CN¥50.3b due within 12 months. So its liabilities total CN¥37.0b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥33.7b, we think shareholders really should watch China International Marine Containers (Group)'s debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

China International Marine Containers (Group)'s net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 4.0 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. If China International Marine Containers (Group) can keep growing EBIT at last year's rate of 13% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China International Marine Containers (Group) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, China International Marine Containers (Group) recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

China International Marine Containers (Group)'s struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to grow its EBIT isn't too shabby at all. When we consider all the factors discussed, it seems to us that China International Marine Containers (Group) is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that China International Marine Containers (Group) is showing 1 warning sign in our investment analysis , you should know about...

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.