Sino-Agri Leading BiosciencesLtd (SHSE:603970) Seems To Use Debt Quite Sensibly

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. As with many other companies Sino-Agri Leading Biosciences Co.,Ltd (SHSE:603970) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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.

View our latest analysis for Sino-Agri Leading BiosciencesLtd

What Is Sino-Agri Leading BiosciencesLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Sino-Agri Leading BiosciencesLtd had CN¥1.15b of debt, an increase on CN¥522.4m, over one year. On the flip side, it has CN¥1.14b in cash leading to net debt of about CN¥8.28m.

A Look At Sino-Agri Leading BiosciencesLtd's Liabilities

The latest balance sheet data shows that Sino-Agri Leading BiosciencesLtd had liabilities of CN¥5.32b due within a year, and liabilities of CN¥22.0m falling due after that. On the other hand, it had cash of CN¥1.14b and CN¥3.13b worth of receivables due within a year. So its liabilities total CN¥1.07b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sino-Agri Leading BiosciencesLtd is worth CN¥3.52b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. But either way, Sino-Agri Leading BiosciencesLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sino-Agri Leading BiosciencesLtd has barely any net debt, as demonstrated by its net debt to EBITDA ratio of only 0.026. Happily, it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like an Olympic ice-skater handles a pirouette. On the other hand, Sino-Agri Leading BiosciencesLtd's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sino-Agri Leading BiosciencesLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Sino-Agri Leading BiosciencesLtd recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Sino-Agri Leading BiosciencesLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its EBIT growth rate has the opposite effect. All these things considered, it appears that Sino-Agri Leading BiosciencesLtd can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Be aware that Sino-Agri Leading BiosciencesLtd is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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.