Here's Why Shanghai Zijiang Enterprise Group (SHSE:600210) Can Manage Its Debt Responsibly

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. As with many other companies Shanghai Zijiang Enterprise Group Co., Ltd. (SHSE:600210) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Zijiang Enterprise Group

What Is Shanghai Zijiang Enterprise Group's Net Debt?

As you can see below, Shanghai Zijiang Enterprise Group had CN¥3.84b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥2.70b in cash leading to net debt of about CN¥1.14b.

A Look At Shanghai Zijiang Enterprise Group's Liabilities

According to the last reported balance sheet, Shanghai Zijiang Enterprise Group had liabilities of CN¥6.64b due within 12 months, and liabilities of CN¥1.27b due beyond 12 months. Offsetting this, it had CN¥2.70b in cash and CN¥1.86b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.36b.

While this might seem like a lot, it is not so bad since Shanghai Zijiang Enterprise Group has a market capitalization of CN¥8.65b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shanghai Zijiang Enterprise Group's net debt is only 0.94 times its EBITDA. And its EBIT easily covers its interest expense, being 32.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Shanghai Zijiang Enterprise Group has increased its EBIT by 7.7% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Zijiang Enterprise Group'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 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. During the last three years, Shanghai Zijiang Enterprise Group generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Shanghai Zijiang Enterprise Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. When we consider the range of factors above, it looks like Shanghai Zijiang Enterprise Group is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shanghai Zijiang Enterprise Group you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.