Does Shanghai Sunglow Packaging TechnologyLtd (SHSE:603499) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Shanghai Sunglow Packaging Technology Co.,Ltd (SHSE:603499) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Sunglow Packaging TechnologyLtd

How Much Debt Does Shanghai Sunglow Packaging TechnologyLtd Carry?

As you can see below, Shanghai Sunglow Packaging TechnologyLtd had CN¥259.4m of debt at September 2023, down from CN¥280.4m a year prior. However, it does have CN¥59.4m in cash offsetting this, leading to net debt of about CN¥200.0m.

How Strong Is Shanghai Sunglow Packaging TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Shanghai Sunglow Packaging TechnologyLtd had liabilities of CN¥282.7m due within 12 months, and liabilities of CN¥232.4m due beyond 12 months. On the other hand, it had cash of CN¥59.4m and CN¥262.0m worth of receivables due within a year. So its liabilities total CN¥193.7m more than the combination of its cash and short-term receivables.

Given Shanghai Sunglow Packaging TechnologyLtd has a market capitalization of CN¥3.67b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

While we wouldn't worry about Shanghai Sunglow Packaging TechnologyLtd's net debt to EBITDA ratio of 2.6, we think its super-low interest cover of 1.5 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, the silver lining was that Shanghai Sunglow Packaging TechnologyLtd achieved a positive EBIT of CN¥29m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Sunglow Packaging TechnologyLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Shanghai Sunglow Packaging TechnologyLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Shanghai Sunglow Packaging TechnologyLtd's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its level of total liabilities gives us reason to be optimistic. Taking the abovementioned factors together we do think Shanghai Sunglow Packaging TechnologyLtd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Shanghai Sunglow Packaging TechnologyLtd (1 makes us a bit uncomfortable) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.