These 4 Measures Indicate That Shanghai Lingang HoldingsLtd (SHSE:600848) Is Using Debt Extensively

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.' 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 note that Shanghai Lingang Holdings Co.,Ltd. (SHSE:600848) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shanghai Lingang HoldingsLtd

What Is Shanghai Lingang HoldingsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Lingang HoldingsLtd had debt of CN¥32.9b, up from CN¥27.0b in one year. However, it does have CN¥7.40b in cash offsetting this, leading to net debt of about CN¥25.5b.

How Strong Is Shanghai Lingang HoldingsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Lingang HoldingsLtd had liabilities of CN¥28.6b due within 12 months and liabilities of CN¥27.0b due beyond that. On the other hand, it had cash of CN¥7.40b and CN¥376.1m worth of receivables due within a year. So it has liabilities totalling CN¥47.8b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥26.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Shanghai Lingang HoldingsLtd would probably need a major re-capitalization if its creditors were to demand repayment.

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 Lingang HoldingsLtd has a rather high debt to EBITDA ratio of 8.3 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.4 times, suggesting it can responsibly service its obligations. However, one redeeming factor is that Shanghai Lingang HoldingsLtd grew its EBIT at 12% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Lingang HoldingsLtd 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Shanghai Lingang HoldingsLtd 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 Lingang HoldingsLtd's conversion of EBIT to free cash flow 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 growing its EBIT; that's encouraging. After considering the datapoints discussed, we think Shanghai Lingang HoldingsLtd has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Shanghai Lingang HoldingsLtd (of which 1 doesn't sit too well with us!) you should know about.

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.