Here's Why Shandong Kaisheng New MaterialsLtd (SZSE:301069) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Shandong Kaisheng New Materials Co.,Ltd. (SZSE:301069) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Kaisheng New MaterialsLtd

What Is Shandong Kaisheng New MaterialsLtd's Debt?

As you can see below, at the end of March 2024, Shandong Kaisheng New MaterialsLtd had CN¥489.9m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥974.0m in cash offsetting this, leading to net cash of CN¥484.1m.

How Healthy Is Shandong Kaisheng New MaterialsLtd's Balance Sheet?

We can see from the most recent balance sheet that Shandong Kaisheng New MaterialsLtd had liabilities of CN¥264.3m falling due within a year, and liabilities of CN¥493.2m due beyond that. Offsetting this, it had CN¥974.0m in cash and CN¥251.0m in receivables that were due within 12 months. So it actually has CN¥467.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Shandong Kaisheng New MaterialsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shandong Kaisheng New MaterialsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Shandong Kaisheng New MaterialsLtd if management cannot prevent a repeat of the 37% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Kaisheng New MaterialsLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shandong Kaisheng New MaterialsLtd 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. Considering the last three years, Shandong Kaisheng New MaterialsLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shandong Kaisheng New MaterialsLtd has net cash of CN¥484.1m, as well as more liquid assets than liabilities. So while Shandong Kaisheng New MaterialsLtd does not have a great balance sheet, it's certainly not too bad. 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 3 warning signs for Shandong Kaisheng New MaterialsLtd that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.