Is Jiangsu SOPO Chemical (SHSE:600746) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Jiangsu SOPO Chemical Co. Ltd. (SHSE:600746) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 Jiangsu SOPO Chemical

How Much Debt Does Jiangsu SOPO Chemical Carry?

As you can see below, at the end of June 2024, Jiangsu SOPO Chemical had CN¥245.8m of debt, up from CN¥86.7m a year ago. Click the image for more detail. But on the other hand it also has CN¥699.7m in cash, leading to a CN¥453.9m net cash position.

A Look At Jiangsu SOPO Chemical's Liabilities

According to the last reported balance sheet, Jiangsu SOPO Chemical had liabilities of CN¥966.9m due within 12 months, and liabilities of CN¥171.4m due beyond 12 months. Offsetting this, it had CN¥699.7m in cash and CN¥668.5m in receivables that were due within 12 months. So it can boast CN¥229.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Jiangsu SOPO Chemical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Jiangsu SOPO Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Jiangsu SOPO Chemical turned things around in the last 12 months, delivering and EBIT of CN¥423m. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangsu SOPO Chemical'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jiangsu SOPO Chemical 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. Looking at the most recent year, Jiangsu SOPO Chemical recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangsu SOPO Chemical has net cash of CN¥453.9m, as well as more liquid assets than liabilities. So we don't have any problem with Jiangsu SOPO Chemical's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Jiangsu SOPO Chemical's earnings per share history for free.

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.