We Think Namchow Food Group (Shanghai) (SHSE:605339) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Namchow Food Group (Shanghai) Co., Ltd. (SHSE:605339) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Namchow Food Group (Shanghai)

How Much Debt Does Namchow Food Group (Shanghai) Carry?

As you can see below, Namchow Food Group (Shanghai) had CN¥320.2m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥1.78b in cash to offset that, meaning it has CN¥1.46b net cash.

How Strong Is Namchow Food Group (Shanghai)'s Balance Sheet?

The latest balance sheet data shows that Namchow Food Group (Shanghai) had liabilities of CN¥764.8m due within a year, and liabilities of CN¥67.4m falling due after that. On the other hand, it had cash of CN¥1.78b and CN¥184.0m worth of receivables due within a year. So it actually has CN¥1.13b more liquid assets than total liabilities.

It's good to see that Namchow Food Group (Shanghai) has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Namchow Food Group (Shanghai) boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Namchow Food Group (Shanghai) if management cannot prevent a repeat of the 48% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Namchow Food Group (Shanghai) 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. Namchow Food Group (Shanghai) may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Namchow Food Group (Shanghai) recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Namchow Food Group (Shanghai) has CN¥1.46b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥284m, being 70% of its EBIT. So we are not troubled with Namchow Food Group (Shanghai)'s debt use. 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, we've discovered 2 warning signs for Namchow Food Group (Shanghai) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.