Shenzhen Cereals HoldingsLtd (SZSE:000019) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Shenzhen Cereals Holdings Co.,Ltd. (SZSE:000019) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shenzhen Cereals HoldingsLtd

What Is Shenzhen Cereals HoldingsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Cereals HoldingsLtd had CN¥1.10b of debt in September 2024, down from CN¥1.48b, one year before. However, it also had CN¥293.5m in cash, and so its net debt is CN¥804.7m.

How Healthy Is Shenzhen Cereals HoldingsLtd's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Cereals HoldingsLtd had liabilities of CN¥2.24b falling due within a year, and liabilities of CN¥135.4m due beyond that. Offsetting this, it had CN¥293.5m in cash and CN¥158.3m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.93b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Shenzhen Cereals HoldingsLtd is worth CN¥7.60b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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

Shenzhen Cereals HoldingsLtd's net debt is only 1.5 times its EBITDA. And its EBIT covers its interest expense a whopping 14.9 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Shenzhen Cereals HoldingsLtd's EBIT dived 10%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Shenzhen Cereals HoldingsLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shenzhen Cereals HoldingsLtd 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.

Our View

Shenzhen Cereals HoldingsLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its EBIT growth rate has the opposite effect. All these things considered, it appears that Shenzhen Cereals HoldingsLtd can comfortably handle its current debt levels. 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. 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, we've discovered 2 warning signs for Shenzhen Cereals HoldingsLtd (1 is a bit unpleasant!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.