We Think Shenzhen Agricultural Products Group (SZSE:000061) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Shenzhen Agricultural Products Group Co., Ltd. (SZSE:000061) 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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shenzhen Agricultural Products Group

How Much Debt Does Shenzhen Agricultural Products Group Carry?

As you can see below, Shenzhen Agricultural Products Group had CN¥6.55b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.65b in cash, and so its net debt is CN¥4.90b.

How Healthy Is Shenzhen Agricultural Products Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Agricultural Products Group had liabilities of CN¥8.52b due within 12 months and liabilities of CN¥4.22b due beyond that. Offsetting these obligations, it had cash of CN¥1.65b as well as receivables valued at CN¥944.8m due within 12 months. So it has liabilities totalling CN¥10.1b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥9.59b, we think shareholders really should watch Shenzhen Agricultural Products 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shenzhen Agricultural Products Group has a debt to EBITDA ratio of 4.0, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Importantly, Shenzhen Agricultural Products Group grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenzhen Agricultural Products Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Shenzhen Agricultural Products Group generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Shenzhen Agricultural Products Group's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that Shenzhen Agricultural Products Group 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Shenzhen Agricultural Products Group has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.