Is Shijiazhuang Shangtai Technology (SZSE:001301) A Risky Investment?

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. We can see that Shijiazhuang Shangtai Technology Co., Ltd. (SZSE:001301) does use debt in its business. But should shareholders be worried about its use of debt?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shijiazhuang Shangtai Technology

What Is Shijiazhuang Shangtai Technology's Debt?

As you can see below, at the end of September 2024, Shijiazhuang Shangtai Technology had CN¥1.51b of debt, up from CN¥1.03b a year ago. Click the image for more detail. However, it also had CN¥290.4m in cash, and so its net debt is CN¥1.22b.

A Look At Shijiazhuang Shangtai Technology's Liabilities

According to the last reported balance sheet, Shijiazhuang Shangtai Technology had liabilities of CN¥1.01b due within 12 months, and liabilities of CN¥1.09b due beyond 12 months. Offsetting this, it had CN¥290.4m in cash and CN¥3.12b in receivables that were due within 12 months. So it actually has CN¥1.31b more liquid assets than total liabilities.

This surplus suggests that Shijiazhuang Shangtai Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shijiazhuang Shangtai Technology's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 21.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Shijiazhuang Shangtai Technology's load is not too heavy, because its EBIT was down 24% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shijiazhuang Shangtai Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Shijiazhuang Shangtai Technology 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.

Our View

Neither Shijiazhuang Shangtai Technology's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Shijiazhuang Shangtai Technology's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shijiazhuang Shangtai Technology has 2 warning signs (and 1 which is concerning) we think 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.