Here's Why Shanghai Chengtou HoldingLtd (SHSE:600649) Is Weighed Down By Its Debt Load

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.' 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. Importantly, Shanghai Chengtou Holding Co.,Ltd (SHSE:600649) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shanghai Chengtou HoldingLtd

What Is Shanghai Chengtou HoldingLtd's Net Debt?

As you can see below, Shanghai Chengtou HoldingLtd had CN¥41.3b 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¥7.21b in cash, and so its net debt is CN¥34.1b.

How Strong Is Shanghai Chengtou HoldingLtd's Balance Sheet?

According to the last reported balance sheet, Shanghai Chengtou HoldingLtd had liabilities of CN¥20.6b due within 12 months, and liabilities of CN¥36.1b due beyond 12 months. Offsetting these obligations, it had cash of CN¥7.21b as well as receivables valued at CN¥1.93b due within 12 months. So it has liabilities totalling CN¥47.5b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥8.09b 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 39.9, it's fair to say Shanghai Chengtou HoldingLtd does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 4.9 times, suggesting it can responsibly service its obligations. Notably, Shanghai Chengtou HoldingLtd's EBIT launched higher than Elon Musk, gaining a whopping 167% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Chengtou HoldingLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Shanghai Chengtou HoldingLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Shanghai Chengtou HoldingLtd's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Shanghai Chengtou HoldingLtd to be really rather risky, as a result of its balance sheet health. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Shanghai Chengtou HoldingLtd (1 can't be ignored) 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.