We Think Sanquan Food (SZSE:002216) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Sanquan Food Co., Ltd. (SZSE:002216) does carry debt. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Sanquan Food

What Is Sanquan Food's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sanquan Food had debt of CN¥450.3m, up from CN¥250.1m in one year. But on the other hand it also has CN¥1.38b in cash, leading to a CN¥930.2m net cash position.

A Look At Sanquan Food's Liabilities

The latest balance sheet data shows that Sanquan Food had liabilities of CN¥2.66b due within a year, and liabilities of CN¥237.8m falling due after that. Offsetting these obligations, it had cash of CN¥1.38b as well as receivables valued at CN¥347.5m due within 12 months. So it has liabilities totalling CN¥1.16b more than its cash and near-term receivables, combined.

Since publicly traded Sanquan Food shares are worth a total of CN¥11.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Sanquan Food also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Sanquan Food if management cannot prevent a repeat of the 34% cut to EBIT 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 Sanquan Food'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, a company can only pay off debt with cold hard cash, not accounting profits. While Sanquan Food 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. During the last three years, Sanquan Food generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Sanquan Food's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥930.2m. And it impressed us with free cash flow of CN¥853m, being 90% of its EBIT. So we don't have any problem with Sanquan Food's use of debt. 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. Be aware that Sanquan Food is showing 1 warning sign in our investment analysis , you should know about...

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.