Is Shandong Huatai Paper Industry ShareholdingLtd (SHSE:600308) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Shandong Huatai Paper Industry Shareholding Co.,Ltd (SHSE:600308) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shandong Huatai Paper Industry ShareholdingLtd

What Is Shandong Huatai Paper Industry ShareholdingLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Shandong Huatai Paper Industry ShareholdingLtd had CN¥2.61b in debt in March 2024; about the same as the year before. However, because it has a cash reserve of CN¥2.31b, its net debt is less, at about CN¥303.0m.

A Look At Shandong Huatai Paper Industry ShareholdingLtd's Liabilities

The latest balance sheet data shows that Shandong Huatai Paper Industry ShareholdingLtd had liabilities of CN¥5.04b due within a year, and liabilities of CN¥1.12b falling due after that. On the other hand, it had cash of CN¥2.31b and CN¥2.76b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.09b.

While this might seem like a lot, it is not so bad since Shandong Huatai Paper Industry ShareholdingLtd has a market capitalization of CN¥5.08b, 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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shandong Huatai Paper Industry ShareholdingLtd has a very low debt to EBITDA ratio of 0.34 so it is strange to see weak interest coverage, with last year's EBIT being only 0.87 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that Shandong Huatai Paper Industry ShareholdingLtd's EBIT was down 96% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shandong Huatai Paper Industry ShareholdingLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Shandong Huatai Paper Industry ShareholdingLtd's free cash flow amounted to 28% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Shandong Huatai Paper Industry ShareholdingLtd's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Shandong Huatai Paper Industry ShareholdingLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Case in point: We've spotted 3 warning signs for Shandong Huatai Paper Industry ShareholdingLtd you should be aware of, and 1 of them is a bit concerning.

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.