Is ShanDong Longhua New MaterialLtd (SZSE:301149) A Risky Investment?

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.' 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. As with many other companies ShanDong Longhua New Material Co.,Ltd. (SZSE:301149) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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 examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does ShanDong Longhua New MaterialLtd Carry?

As you can see below, at the end of September 2024, ShanDong Longhua New MaterialLtd had CN¥811.4m of debt, up from CN¥340.4m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.02b in cash, leading to a CN¥211.0m net cash position.

How Healthy Is ShanDong Longhua New MaterialLtd's Balance Sheet?

The latest balance sheet data shows that ShanDong Longhua New MaterialLtd had liabilities of CN¥957.6m due within a year, and liabilities of CN¥434.2m falling due after that. Offsetting this, it had CN¥1.02b in cash and CN¥272.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥97.0m more than its cash and near-term receivables, combined.

Of course, ShanDong Longhua New MaterialLtd has a market capitalization of CN¥4.73b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, ShanDong Longhua New MaterialLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Check out our latest analysis for ShanDong Longhua New MaterialLtd

But the other side of the story is that ShanDong Longhua New MaterialLtd saw its EBIT decline by 3.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since ShanDong Longhua New MaterialLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While ShanDong Longhua New MaterialLtd 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. Over the last three years, ShanDong Longhua New MaterialLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that ShanDong Longhua New MaterialLtd has CN¥211.0m in net cash. So we don't have any problem with ShanDong Longhua New MaterialLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for ShanDong Longhua New MaterialLtd (1 shouldn't be ignored!) that you should be aware of before investing here.

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.