Here's Why ShanDongDenghai SeedsLtd (SZSE:002041) Can Manage Its Debt Responsibly

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.' 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. Importantly, ShanDongDenghai Seeds Co.,Ltd (SZSE:002041) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for ShanDongDenghai SeedsLtd

What Is ShanDongDenghai SeedsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 ShanDongDenghai SeedsLtd had CN¥21.8m of debt, an increase on CN¥12.9m, over one year. But on the other hand it also has CN¥3.06b in cash, leading to a CN¥3.04b net cash position.

A Look At ShanDongDenghai SeedsLtd's Liabilities

The latest balance sheet data shows that ShanDongDenghai SeedsLtd had liabilities of CN¥1.11b due within a year, and liabilities of CN¥82.5m falling due after that. Offsetting these obligations, it had cash of CN¥3.06b as well as receivables valued at CN¥40.5m due within 12 months. So it actually has CN¥1.91b more liquid assets than total liabilities.

It's good to see that ShanDongDenghai SeedsLtd 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. Simply put, the fact that ShanDongDenghai SeedsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that ShanDongDenghai SeedsLtd's load is not too heavy, because its EBIT was down 44% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 ShanDongDenghai SeedsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ShanDongDenghai SeedsLtd 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 last three years, ShanDongDenghai SeedsLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that ShanDongDenghai SeedsLtd has net cash of CN¥3.04b, as well as more liquid assets than liabilities. So we are not troubled with ShanDongDenghai SeedsLtd's debt use. 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 ShanDongDenghai SeedsLtd 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.

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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.