We Think Sanxiang Advanced Materials (SHSE:603663) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Sanxiang Advanced Materials Co., Ltd. (SHSE:603663) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Sanxiang Advanced Materials

What Is Sanxiang Advanced Materials's Debt?

As you can see below, at the end of September 2023, Sanxiang Advanced Materials had CN¥336.7m of debt, up from CN¥248.2m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥73.4m, its net debt is less, at about CN¥263.2m.

A Look At Sanxiang Advanced Materials' Liabilities

Zooming in on the latest balance sheet data, we can see that Sanxiang Advanced Materials had liabilities of CN¥600.6m due within 12 months and liabilities of CN¥64.9m due beyond that. Offsetting these obligations, it had cash of CN¥73.4m as well as receivables valued at CN¥422.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥169.8m.

Of course, Sanxiang Advanced Materials has a market capitalization of CN¥4.61b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sanxiang Advanced Materials's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 24.9 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Sanxiang Advanced Materials's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sanxiang Advanced Materials'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Sanxiang Advanced Materials reported free cash flow worth 13% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Sanxiang Advanced Materials was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. In particular, EBIT growth rate gives us cold feet. When we consider all the factors mentioned above, we do feel a bit cautious about Sanxiang Advanced Materials's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For instance, we've identified 3 warning signs for Sanxiang Advanced Materials that 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.