Here's Why Shaanxi Sirui Advanced Materials (SHSE:688102) Can Manage Its Debt Responsibly

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 Shaanxi Sirui Advanced Materials Co., Ltd. (SHSE:688102) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shaanxi Sirui Advanced Materials

What Is Shaanxi Sirui Advanced Materials's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Shaanxi Sirui Advanced Materials had debt of CN¥532.4m, up from CN¥290.4m in one year. However, it does have CN¥164.6m in cash offsetting this, leading to net debt of about CN¥367.8m.

A Look At Shaanxi Sirui Advanced Materials' Liabilities

Zooming in on the latest balance sheet data, we can see that Shaanxi Sirui Advanced Materials had liabilities of CN¥494.1m due within 12 months and liabilities of CN¥287.0m due beyond that. On the other hand, it had cash of CN¥164.6m and CN¥303.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥312.9m.

Of course, Shaanxi Sirui Advanced Materials has a market capitalization of CN¥6.78b, 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 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). 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).

Shaanxi Sirui Advanced Materials's net debt of 2.3 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.6 times interest expense) certainly does not do anything to dispel this impression. Notably, Shaanxi Sirui Advanced Materials's EBIT launched higher than Elon Musk, gaining a whopping 128% on last year. 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 Shaanxi Sirui Advanced Materials can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Shaanxi Sirui Advanced Materials burned a lot of cash. 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

Based on what we've seen Shaanxi Sirui Advanced Materials is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. Considering this range of data points, we think Shaanxi Sirui Advanced Materials is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shaanxi Sirui Advanced Materials you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.