Is Shandong Longhua New Material (SZSE:301149) A Risky Investment?

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.' 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 note that Shandong Longhua New Material Co., Ltd. (SZSE:301149) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shandong Longhua New Material

How Much Debt Does Shandong Longhua New Material Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shandong Longhua New Material had debt of CN¥811.4m, up from CN¥340.4m in one year. However, its balance sheet shows it holds CN¥1.02b in cash, so it actually has CN¥211.0m net cash.

How Strong Is Shandong Longhua New Material's Balance Sheet?

According to the last reported balance sheet, Shandong Longhua New Material had liabilities of CN¥957.6m due within 12 months, and liabilities of CN¥434.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.02b as well as receivables valued at CN¥272.4m due within 12 months. So it has liabilities totalling CN¥97.0m more than its cash and near-term receivables, combined.

Since publicly traded Shandong Longhua New Material shares are worth a total of CN¥4.27b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Shandong Longhua New Material boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Shandong Longhua New Material saw its EBIT decline by 3.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shandong Longhua New Material 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shandong Longhua New Material has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Shandong Longhua New Material burned a lot of cash. 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.

Summing Up

We could understand if investors are concerned about Shandong Longhua New Material's liabilities, but we can be reassured by the fact it has has net cash of CN¥211.0m. So we don't have any problem with Shandong Longhua New Material's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shandong Longhua New Material (of which 1 doesn't sit too well with us!) you should know about.

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.