Here's Why Shanghai Zhangjiang Hi-Tech Park Development (SHSE:600895) 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. We can see that Shanghai Zhangjiang Hi-Tech Park Development Co., Ltd. (SHSE:600895) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Zhangjiang Hi-Tech Park Development

What Is Shanghai Zhangjiang Hi-Tech Park Development's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Zhangjiang Hi-Tech Park Development had debt of CN¥29.3b, up from CN¥24.9b in one year. However, it also had CN¥2.38b in cash, and so its net debt is CN¥27.0b.

How Healthy Is Shanghai Zhangjiang Hi-Tech Park Development's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Zhangjiang Hi-Tech Park Development had liabilities of CN¥14.8b falling due within a year, and liabilities of CN¥23.6b due beyond that. Offsetting this, it had CN¥2.38b in cash and CN¥326.6m in receivables that were due within 12 months. So its liabilities total CN¥35.7b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥45.9b, so it does suggest shareholders should keep an eye on Shanghai Zhangjiang Hi-Tech Park Development's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 30.2 hit our confidence in Shanghai Zhangjiang Hi-Tech Park Development like a one-two punch to the gut. The debt burden here is substantial. Worse, Shanghai Zhangjiang Hi-Tech Park Development's EBIT was down 42% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Zhangjiang Hi-Tech Park Development'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 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 Zhangjiang Hi-Tech Park Development 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

To be frank both Shanghai Zhangjiang Hi-Tech Park Development's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Shanghai Zhangjiang Hi-Tech Park Development has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Shanghai Zhangjiang Hi-Tech Park Development (1 shouldn't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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

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.