Shijiazhuang Shangtai Technology (SZSE:001301) 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.' 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. Importantly, Shijiazhuang Shangtai Technology Co., Ltd. (SZSE:001301) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shijiazhuang Shangtai Technology

What Is Shijiazhuang Shangtai Technology's Net Debt?

As you can see below, at the end of June 2024, Shijiazhuang Shangtai Technology had CN¥1.19b of debt, up from CN¥841.2m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥294.9m, its net debt is less, at about CN¥898.8m.

How Healthy Is Shijiazhuang Shangtai Technology's Balance Sheet?

The latest balance sheet data shows that Shijiazhuang Shangtai Technology had liabilities of CN¥1.13b due within a year, and liabilities of CN¥658.7m falling due after that. Offsetting this, it had CN¥294.9m in cash and CN¥2.93b in receivables that were due within 12 months. So it can boast CN¥1.44b more liquid assets than total liabilities.

This short term liquidity is a sign that Shijiazhuang Shangtai Technology could probably pay off its debt with ease, as its balance sheet is far from stretched.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shijiazhuang Shangtai Technology's net debt is only 0.82 times its EBITDA. And its EBIT covers its interest expense a whopping 30.8 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Shijiazhuang Shangtai Technology's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Shijiazhuang Shangtai Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Shijiazhuang Shangtai Technology's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. 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. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example - Shijiazhuang Shangtai Technology has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.