Shanghai Bairun Investment Holding Group (SZSE:002568) Seems To Use Debt Quite Sensibly

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 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. As with many other companies Shanghai Bairun Investment Holding Group Co., Ltd. (SZSE:002568) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shanghai Bairun Investment Holding Group

How Much Debt Does Shanghai Bairun Investment Holding Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Bairun Investment Holding Group had CN¥2.29b of debt, an increase on CN¥2.19b, over one year. However, because it has a cash reserve of CN¥1.99b, its net debt is less, at about CN¥298.2m.

How Healthy Is Shanghai Bairun Investment Holding Group's Balance Sheet?

The latest balance sheet data shows that Shanghai Bairun Investment Holding Group had liabilities of CN¥2.08b due within a year, and liabilities of CN¥1.30b falling due after that. Offsetting these obligations, it had cash of CN¥1.99b as well as receivables valued at CN¥335.4m due within 12 months. So it has liabilities totalling CN¥1.05b more than its cash and near-term receivables, combined.

Of course, Shanghai Bairun Investment Holding Group has a market capitalization of CN¥25.0b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Shanghai Bairun Investment Holding Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shanghai Bairun Investment Holding Group's net debt is only 0.27 times its EBITDA. And its EBIT covers its interest expense a whopping 48.9 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Shanghai Bairun Investment Holding Group's EBIT dived 15%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Bairun Investment Holding Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Shanghai Bairun Investment Holding Group created free cash flow amounting to 2.1% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Both Shanghai Bairun Investment Holding Group's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. But truth be told its EBIT growth rate had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about Shanghai Bairun Investment Holding Group's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Shanghai Bairun Investment Holding Group that 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.