Is Shanghai Zijiang Enterprise Group (SHSE:600210) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Shanghai Zijiang Enterprise Group Co., Ltd. (SHSE:600210) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shanghai Zijiang Enterprise Group

What Is Shanghai Zijiang Enterprise Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Shanghai Zijiang Enterprise Group had CN¥3.82b in debt in June 2024; about the same as the year before. On the flip side, it has CN¥2.77b in cash leading to net debt of about CN¥1.05b.

A Look At Shanghai Zijiang Enterprise Group's Liabilities

According to the last reported balance sheet, Shanghai Zijiang Enterprise Group had liabilities of CN¥6.97b due within 12 months, and liabilities of CN¥1.69b due beyond 12 months. Offsetting this, it had CN¥2.77b in cash and CN¥2.14b in receivables that were due within 12 months. So its liabilities total CN¥3.76b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shanghai Zijiang Enterprise Group has a market capitalization of CN¥7.71b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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 Zijiang Enterprise Group has a low net debt to EBITDA ratio of only 0.87. And its EBIT covers its interest expense a whopping 26.4 times over. 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 4.2% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Zijiang Enterprise Group can strengthen its balance sheet over time. 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Shanghai Zijiang Enterprise Group produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Shanghai Zijiang Enterprise Group's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Shanghai Zijiang Enterprise Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Shanghai Zijiang Enterprise Group 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.