We Think Henan Shuanghui Investment & DevelopmentLtd (SZSE:000895) Can Stay On Top Of Its Debt

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. We note that Henan Shuanghui Investment & Development Co.,Ltd. (SZSE:000895) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Henan Shuanghui Investment & DevelopmentLtd

How Much Debt Does Henan Shuanghui Investment & DevelopmentLtd Carry?

As you can see below, Henan Shuanghui Investment & DevelopmentLtd had CN¥10.5b of debt at September 2024, down from CN¥13.3b a year prior. However, it does have CN¥8.67b in cash offsetting this, leading to net debt of about CN¥1.84b.

How Strong Is Henan Shuanghui Investment & DevelopmentLtd's Balance Sheet?

The latest balance sheet data shows that Henan Shuanghui Investment & DevelopmentLtd had liabilities of CN¥16.7b due within a year, and liabilities of CN¥1.39b falling due after that. Offsetting these obligations, it had cash of CN¥8.67b as well as receivables valued at CN¥562.5m due within 12 months. So it has liabilities totalling CN¥8.82b more than its cash and near-term receivables, combined.

Of course, Henan Shuanghui Investment & DevelopmentLtd has a titanic market capitalization of CN¥86.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

Henan Shuanghui Investment & DevelopmentLtd's net debt is only 0.24 times its EBITDA. And its EBIT easily covers its interest expense, being 173 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Henan Shuanghui Investment & DevelopmentLtd's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Henan Shuanghui Investment & DevelopmentLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Henan Shuanghui Investment & DevelopmentLtd produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Henan Shuanghui Investment & DevelopmentLtd'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 Henan Shuanghui Investment & DevelopmentLtd 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Henan Shuanghui Investment & DevelopmentLtd that you should be aware of before investing here.

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.