Shuhua Sports (SHSE:605299) Has A Rock Solid Balance Sheet

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. As with many other companies Shuhua Sports Co., Ltd. (SHSE:605299) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shuhua Sports

What Is Shuhua Sports's Net Debt?

As you can see below, at the end of December 2023, Shuhua Sports had CN¥205.0m of debt, up from CN¥136.7m a year ago. Click the image for more detail. However, it does have CN¥608.2m in cash offsetting this, leading to net cash of CN¥403.2m.

How Strong Is Shuhua Sports' Balance Sheet?

According to the last reported balance sheet, Shuhua Sports had liabilities of CN¥567.9m due within 12 months, and liabilities of CN¥80.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥608.2m as well as receivables valued at CN¥323.9m due within 12 months. So it actually has CN¥283.4m more liquid assets than total liabilities.

This surplus suggests that Shuhua Sports has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shuhua Sports has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Shuhua Sports has increased its EBIT by 5.9% over twelve months, which should ease any concerns about debt repayment. 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 Shuhua Sports'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. While Shuhua Sports has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Shuhua Sports actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shuhua Sports has CN¥403.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 112% of that EBIT to free cash flow, bringing in CN¥216m. So we don't think Shuhua Sports's use of debt is risky. 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 - Shuhua Sports has 1 warning sign 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.