Here's Why Shanghai Shibei Hi-TechLtd (SHSE:600604) Is Weighed Down By Its Debt Load

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.' 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 Shanghai Shibei Hi-Tech Co.,Ltd. (SHSE:600604) does have debt on its balance sheet. But is this debt a concern to shareholders?

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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shanghai Shibei Hi-TechLtd

What Is Shanghai Shibei Hi-TechLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Shanghai Shibei Hi-TechLtd had CN¥8.96b in debt in September 2024; about the same as the year before. However, it also had CN¥855.1m in cash, and so its net debt is CN¥8.10b.

A Look At Shanghai Shibei Hi-TechLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Shibei Hi-TechLtd had liabilities of CN¥7.12b due within 12 months and liabilities of CN¥6.36b due beyond that. Offsetting these obligations, it had cash of CN¥855.1m as well as receivables valued at CN¥216.9m due within 12 months. So it has liabilities totalling CN¥12.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥7.85b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Shanghai Shibei Hi-TechLtd would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.19 times and a disturbingly high net debt to EBITDA ratio of 20.6 hit our confidence in Shanghai Shibei Hi-TechLtd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Shanghai Shibei Hi-TechLtd saw its EBIT tank 77% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Shanghai Shibei Hi-TechLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Shanghai Shibei Hi-TechLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, Shanghai Shibei Hi-TechLtd's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Shanghai Shibei Hi-TechLtd's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 2 warning signs for Shanghai Shibei Hi-TechLtd 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.