Shanghai Emperor of Cleaning Hi-Tech (SHSE:603200) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Emperor of Cleaning Hi-Tech Co., Ltd (SHSE:603200) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Emperor of Cleaning Hi-Tech

How Much Debt Does Shanghai Emperor of Cleaning Hi-Tech Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Emperor of Cleaning Hi-Tech had debt of CN¥300.8m, up from CN¥224.7m in one year. However, it does have CN¥181.4m in cash offsetting this, leading to net debt of about CN¥119.4m.

How Healthy Is Shanghai Emperor of Cleaning Hi-Tech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Emperor of Cleaning Hi-Tech had liabilities of CN¥518.4m due within 12 months and liabilities of CN¥57.6m due beyond that. Offsetting these obligations, it had cash of CN¥181.4m as well as receivables valued at CN¥485.2m due within 12 months. So it can boast CN¥90.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Emperor of Cleaning Hi-Tech could probably pay off its debt with ease, as its balance sheet is far from stretched.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Shanghai Emperor of Cleaning Hi-Tech's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. It is well worth noting that Shanghai Emperor of Cleaning Hi-Tech's EBIT shot up like bamboo after rain, gaining 60% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Emperor of Cleaning Hi-Tech's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Shanghai Emperor of Cleaning Hi-Tech actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Happily, Shanghai Emperor of Cleaning Hi-Tech's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Shanghai Emperor of Cleaning Hi-Tech can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shanghai Emperor of Cleaning Hi-Tech's earnings per share history for free.

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.