Here's Why Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd (SHSE:600663) Has A Meaningful Debt Burden

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shanghai Lujiazui Finance & Trade Zone Development Co.,Ltd. (SHSE:600663) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd

How Much Debt Does Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd Carry?

As you can see below, at the end of March 2024, Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd had CN¥67.7b of debt, up from CN¥60.1b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥8.30b, its net debt is less, at about CN¥59.4b.

How Strong Is Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's Balance Sheet?

The latest balance sheet data shows that Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd had liabilities of CN¥75.3b due within a year, and liabilities of CN¥32.8b falling due after that. Offsetting these obligations, it had cash of CN¥8.30b as well as receivables valued at CN¥2.73b due within 12 months. So it has liabilities totalling CN¥97.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥37.0b 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 Lujiazui Finance & Trade Zone DevelopmentLtd would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd has a rather high debt to EBITDA ratio of 12.0 which suggests a meaningful debt load. However, its interest coverage of 3.2 is reasonably strong, which is a good sign. On the other hand, Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd grew its EBIT by 25% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. 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 Lujiazui Finance & Trade Zone DevelopmentLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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 Lujiazui Finance & Trade Zone DevelopmentLtd reported free cash flow worth 17% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's net debt to EBITDA 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 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 Lujiazui Finance & Trade Zone DevelopmentLtd 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd (including 2 which shouldn't be ignored) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com