Does Shanghai Chengtou HoldingLtd (SHSE:600649) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shanghai Chengtou Holding Co.,Ltd (SHSE:600649) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shanghai Chengtou HoldingLtd

How Much Debt Does Shanghai Chengtou HoldingLtd Carry?

As you can see below, Shanghai Chengtou HoldingLtd had CN¥39.0b of debt at September 2024, down from CN¥42.7b a year prior. On the flip side, it has CN¥9.75b in cash leading to net debt of about CN¥29.2b.

How Healthy Is Shanghai Chengtou HoldingLtd's Balance Sheet?

The latest balance sheet data shows that Shanghai Chengtou HoldingLtd had liabilities of CN¥26.3b due within a year, and liabilities of CN¥34.7b falling due after that. Offsetting this, it had CN¥9.75b in cash and CN¥1.94b in receivables that were due within 12 months. So its liabilities total CN¥49.4b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥11.5b 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. At the end of the day, Shanghai Chengtou HoldingLtd 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shanghai Chengtou HoldingLtd shareholders face the double whammy of a high net debt to EBITDA ratio (68.7), and fairly weak interest coverage, since EBIT is just 0.56 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Shanghai Chengtou HoldingLtd saw its EBIT tank 75% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Chengtou HoldingLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shanghai Chengtou HoldingLtd 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.

Our View

On the face of it, Shanghai Chengtou HoldingLtd'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. And even its interest cover fails to inspire much confidence. It looks to us like Shanghai Chengtou HoldingLtd carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. For example Shanghai Chengtou HoldingLtd has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.