Sanxiang Advanced Materials (SHSE:603663) Has A Somewhat Strained 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.' 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. We note that Sanxiang Advanced Materials Co., Ltd. (SHSE:603663) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sanxiang Advanced Materials

What Is Sanxiang Advanced Materials's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Sanxiang Advanced Materials had debt of CN¥477.8m, up from CN¥285.5m in one year. However, because it has a cash reserve of CN¥91.1m, its net debt is less, at about CN¥386.7m.

How Healthy Is Sanxiang Advanced Materials' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sanxiang Advanced Materials had liabilities of CN¥730.0m due within 12 months and liabilities of CN¥43.1m due beyond that. Offsetting this, it had CN¥91.1m in cash and CN¥529.5m in receivables that were due within 12 months. So its liabilities total CN¥152.5m more than the combination of its cash and short-term receivables.

Of course, Sanxiang Advanced Materials has a market capitalization of CN¥7.19b, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt to EBITDA of 2.7 Sanxiang Advanced Materials has a fairly noticeable amount of debt. But the high interest coverage of 8.3 suggests it can easily service that debt. Importantly, Sanxiang Advanced Materials's EBIT fell a jaw-dropping 57% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sanxiang Advanced Materials 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Sanxiang Advanced Materials actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Both Sanxiang Advanced Materials's EBIT growth rate and its conversion of EBIT to free cash flow were discouraging. At least its interest cover gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Sanxiang Advanced Materials is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 example, we've discovered 1 warning sign for Sanxiang Advanced Materials that you should be aware of before investing here.

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.