Is Shanghai Shibei Hi-TechLtd (SHSE:600604) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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?

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 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, 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.

Check out our latest analysis for Shanghai Shibei Hi-TechLtd

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

As you can see below, Shanghai Shibei Hi-TechLtd had CN¥9.23b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.06b in cash, and so its net debt is CN¥8.17b.

How Strong Is Shanghai Shibei Hi-TechLtd's Balance Sheet?

According to the last reported balance sheet, Shanghai Shibei Hi-TechLtd had liabilities of CN¥6.95b due within 12 months, and liabilities of CN¥6.59b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.06b as well as receivables valued at CN¥143.0m due within 12 months. So its liabilities total CN¥12.3b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥5.44b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Shanghai Shibei Hi-TechLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shanghai Shibei Hi-TechLtd shareholders face the double whammy of a high net debt to EBITDA ratio (20.2), and fairly weak interest coverage, since EBIT is just 0.30 times the interest expense. The debt burden here is substantial. Even worse, Shanghai Shibei Hi-TechLtd saw its EBIT tank 66% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shanghai Shibei Hi-TechLtd's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shanghai Shibei Hi-TechLtd recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

On the face of it, Shanghai Shibei Hi-TechLtd's EBIT growth rate left us tentative about the stock, and its level of total liabilities 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. Taking into account all the aforementioned factors, it looks like Shanghai Shibei Hi-TechLtd has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. Case in point: We've spotted 2 warning signs for Shanghai Shibei Hi-TechLtd you should be aware of.

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.