These 4 Measures Indicate That Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd (SHSE:600663) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Lujiazui Finance & Trade Zone DevelopmentLtd

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

As you can see below, Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd had CN¥67.6b of debt at September 2024, down from CN¥74.7b a year prior. However, it does have CN¥10.6b in cash offsetting this, leading to net debt of about CN¥57.0b.

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

We can see from the most recent balance sheet that Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd had liabilities of CN¥74.7b falling due within a year, and liabilities of CN¥35.9b due beyond that. Offsetting this, it had CN¥10.6b in cash and CN¥1.76b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥98.2b.

This deficit casts a shadow over the CN¥45.1b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. 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 11.5 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.7 times, suggesting it can responsibly service its obligations. The good news is that Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd grew its EBIT a smooth 32% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. To that end, you should learn about the 4 warning signs we've spotted with Shanghai Lujiazui Finance & Trade Zone DevelopmentLtd (including 2 which are a bit concerning) .

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.