Is Shanghai Chemspec (SHSE:688602) Using Debt In A Risky Way?

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.' 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 Shanghai Chemspec Corporation (SHSE:688602) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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.

See our latest analysis for Shanghai Chemspec

What Is Shanghai Chemspec's Debt?

As you can see below, Shanghai Chemspec had CN¥203.3m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥1.24b in cash, so it actually has CN¥1.03b net cash.

How Strong Is Shanghai Chemspec's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Chemspec had liabilities of CN¥462.8m falling due within a year, and liabilities of CN¥83.8m due beyond that. Offsetting these obligations, it had cash of CN¥1.24b as well as receivables valued at CN¥230.3m due within 12 months. So it actually has CN¥919.6m more liquid assets than total liabilities.

This excess liquidity suggests that Shanghai Chemspec is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Shanghai Chemspec has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Chemspec will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Shanghai Chemspec made a loss at the EBIT level, and saw its revenue drop to CN¥709m, which is a fall of 33%. That makes us nervous, to say the least.

So How Risky Is Shanghai Chemspec?

Although Shanghai Chemspec had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥67m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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. For instance, we've identified 2 warning signs for Shanghai Chemspec (1 makes us a bit uncomfortable) you should be aware of.

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.