Shenzhen Noposion Crop Science (SZSE:002215) Takes On Some Risk With Its Use Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Shenzhen Noposion Crop Science Co., Ltd. (SZSE:002215) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shenzhen Noposion Crop Science

How Much Debt Does Shenzhen Noposion Crop Science Carry?

The chart below, which you can click on for greater detail, shows that Shenzhen Noposion Crop Science had CN¥5.05b in debt in September 2024; about the same as the year before. On the flip side, it has CN¥1.36b in cash leading to net debt of about CN¥3.69b.

How Strong Is Shenzhen Noposion Crop Science's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Noposion Crop Science had liabilities of CN¥5.91b falling due within a year, and liabilities of CN¥1.53b due beyond that. Offsetting these obligations, it had cash of CN¥1.36b as well as receivables valued at CN¥1.18b due within 12 months. So it has liabilities totalling CN¥4.91b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Shenzhen Noposion Crop Science is worth CN¥9.43b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Shenzhen Noposion Crop Science has a sky high EBITDA ratio of 5.0, implying high debt, but a strong interest coverage of 15.3. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, Shenzhen Noposion Crop Science grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shenzhen Noposion Crop Science'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shenzhen Noposion Crop Science burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Shenzhen Noposion Crop Science's conversion of EBIT to free cash flow has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. We think that Shenzhen Noposion Crop Science's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shenzhen Noposion Crop Science you should know about.

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.