Jiangsu Eastern ShenghongLtd (SZSE:000301) Use Of Debt Could Be Considered Risky

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Jiangsu Eastern Shenghong Co.,Ltd. (SZSE:000301) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Jiangsu Eastern ShenghongLtd

What Is Jiangsu Eastern ShenghongLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Jiangsu Eastern ShenghongLtd had debt of CN¥121.8b, up from CN¥98.4b in one year. However, it also had CN¥12.7b in cash, and so its net debt is CN¥109.1b.

A Look At Jiangsu Eastern ShenghongLtd's Liabilities

According to the last reported balance sheet, Jiangsu Eastern ShenghongLtd had liabilities of CN¥69.3b due within 12 months, and liabilities of CN¥80.4b due beyond 12 months. On the other hand, it had cash of CN¥12.7b and CN¥2.81b worth of receivables due within a year. So its liabilities total CN¥134.1b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥65.6b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Jiangsu Eastern ShenghongLtd would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.8 times and a disturbingly high net debt to EBITDA ratio of 15.3 hit our confidence in Jiangsu Eastern ShenghongLtd like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Jiangsu Eastern ShenghongLtd boosted its EBIT by a silky 33% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Jiangsu Eastern ShenghongLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Jiangsu Eastern ShenghongLtd saw substantial negative free cash flow, in total. 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

On the face of it, Jiangsu Eastern ShenghongLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Jiangsu Eastern ShenghongLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 4 warning signs for Jiangsu Eastern ShenghongLtd (1 is potentially serious!) 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.