Is Shanghai Zhangjiang Hi-Tech Park Development (SHSE:600895) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Shanghai Zhangjiang Hi-Tech Park Development Co., Ltd. (SHSE:600895) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Zhangjiang Hi-Tech Park Development

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

The image below, which you can click on for greater detail, shows that at March 2024 Shanghai Zhangjiang Hi-Tech Park Development had debt of CN¥27.9b, up from CN¥23.0b in one year. However, it also had CN¥2.81b in cash, and so its net debt is CN¥25.1b.

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¥16.6b falling due within a year, and liabilities of CN¥19.5b due beyond that. On the other hand, it had cash of CN¥2.81b and CN¥287.1m worth of receivables due within a year. So its liabilities total CN¥33.0b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥28.9b, we think shareholders really should watch Shanghai Zhangjiang Hi-Tech Park Development's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shanghai Zhangjiang Hi-Tech Park Development has a rather high debt to EBITDA ratio of 16.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.1 times, suggesting it can responsibly service its obligations. However, it should be some comfort for shareholders to recall that Shanghai Zhangjiang Hi-Tech Park Development actually grew its EBIT by a hefty 254%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. 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 Zhangjiang Hi-Tech Park Development 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 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 net debt to EBITDA and its track record of converting EBIT to free cash flow 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 Zhangjiang Hi-Tech Park Development 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Shanghai Zhangjiang Hi-Tech Park Development (1 is potentially serious) you should be aware of.

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.

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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.