These 4 Measures Indicate That ShanDongDenghai SeedsLtd (SZSE:002041) Is Using Debt Reasonably Well

Warren Buffett famously said, '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. Importantly, ShanDongDenghai Seeds Co.,Ltd (SZSE:002041) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for ShanDongDenghai SeedsLtd

How Much Debt Does ShanDongDenghai SeedsLtd Carry?

As you can see below, at the end of June 2024, ShanDongDenghai SeedsLtd had CN¥28.0m of debt, up from CN¥20.5m a year ago. Click the image for more detail. But it also has CN¥2.84b in cash to offset that, meaning it has CN¥2.81b net cash.

How Healthy Is ShanDongDenghai SeedsLtd's Balance Sheet?

According to the last reported balance sheet, ShanDongDenghai SeedsLtd had liabilities of CN¥700.5m due within 12 months, and liabilities of CN¥126.2m due beyond 12 months. Offsetting this, it had CN¥2.84b in cash and CN¥67.7m in receivables that were due within 12 months. So it actually has CN¥2.08b 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. Given it has easily adequate short term liquidity, we don't think it will have any 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.

On the other hand, ShanDongDenghai SeedsLtd'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ShanDongDenghai SeedsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While ShanDongDenghai SeedsLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, ShanDongDenghai SeedsLtd's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case ShanDongDenghai SeedsLtd has CN¥2.81b in net cash and a decent-looking balance sheet. So we are not troubled with ShanDongDenghai SeedsLtd's debt use. 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 - ShanDongDenghai SeedsLtd has 1 warning sign we think you should be aware of.

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.