Here's Why Shanghai Sunglow Packaging TechnologyLtd (SHSE:603499) Has A Meaningful Debt Burden

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. Importantly, Shanghai Sunglow Packaging Technology Co.,Ltd (SHSE:603499) does carry debt. But the more important question is: how much risk is that debt creating?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shanghai Sunglow Packaging TechnologyLtd

What Is Shanghai Sunglow Packaging TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shanghai Sunglow Packaging TechnologyLtd had CN¥241.6m of debt in June 2024, down from CN¥282.8m, one year before. However, because it has a cash reserve of CN¥56.4m, its net debt is less, at about CN¥185.2m.

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

Zooming in on the latest balance sheet data, we can see that Shanghai Sunglow Packaging TechnologyLtd had liabilities of CN¥367.1m due within 12 months and liabilities of CN¥174.0m due beyond that. On the other hand, it had cash of CN¥56.4m and CN¥261.5m worth of receivables due within a year. So it has liabilities totalling CN¥223.3m more than its cash and near-term receivables, combined.

Of course, Shanghai Sunglow Packaging TechnologyLtd has a market capitalization of CN¥4.99b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Even though Shanghai Sunglow Packaging TechnologyLtd's debt is only 2.1, its interest cover is really very low at 2.0. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Also relevant is that Shanghai Sunglow Packaging TechnologyLtd has grown its EBIT by a very respectable 24% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Shanghai Sunglow Packaging TechnologyLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shanghai Sunglow Packaging TechnologyLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Both Shanghai Sunglow Packaging TechnologyLtd's conversion of EBIT to free cash flow and its interest cover were discouraging. But on the brighter side of life, its EBIT growth rate leaves us feeling more frolicsome. We think that Shanghai Sunglow Packaging TechnologyLtd's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. 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 3 warning signs for Shanghai Sunglow Packaging TechnologyLtd (of which 1 makes us a bit uncomfortable!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.