Shandong HaihuaLtd (SZSE:000822) Seems To Use Debt Quite Sensibly

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. Importantly, Shandong Haihua Co.,Ltd (SZSE:000822) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Shandong HaihuaLtd

What Is Shandong HaihuaLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shandong HaihuaLtd had CN¥225.1m of debt, an increase on CN¥100.0m, over one year. However, it does have CN¥1.30b in cash offsetting this, leading to net cash of CN¥1.08b.

A Look At Shandong HaihuaLtd's Liabilities

The latest balance sheet data shows that Shandong HaihuaLtd had liabilities of CN¥2.04b due within a year, and liabilities of CN¥549.2m falling due after that. Offsetting this, it had CN¥1.30b in cash and CN¥2.78b in receivables that were due within 12 months. So it actually has CN¥1.49b more liquid assets than total liabilities.

This surplus suggests that Shandong HaihuaLtd is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Shandong HaihuaLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Shandong HaihuaLtd's EBIT dived 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shandong HaihuaLtd will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shandong HaihuaLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Shandong HaihuaLtd's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shandong HaihuaLtd has CN¥1.08b in net cash and a decent-looking balance sheet. So we don't have any problem with Shandong HaihuaLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Shandong HaihuaLtd (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.