Shenzhen Kingkey Smart Agriculture TimesLtd (SZSE:000048) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shenzhen Kingkey Smart Agriculture Times Co.,Ltd (SZSE:000048) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shenzhen Kingkey Smart Agriculture TimesLtd

How Much Debt Does Shenzhen Kingkey Smart Agriculture TimesLtd Carry?

As you can see below, at the end of March 2024, Shenzhen Kingkey Smart Agriculture TimesLtd had CN¥2.61b of debt, up from CN¥2.10b a year ago. Click the image for more detail. On the flip side, it has CN¥898.6m in cash leading to net debt of about CN¥1.71b.

How Strong Is Shenzhen Kingkey Smart Agriculture TimesLtd's Balance Sheet?

The latest balance sheet data shows that Shenzhen Kingkey Smart Agriculture TimesLtd had liabilities of CN¥6.20b due within a year, and liabilities of CN¥1.68b falling due after that. Offsetting this, it had CN¥898.6m in cash and CN¥120.6m in receivables that were due within 12 months. So its liabilities total CN¥6.86b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥9.78b, so it does suggest shareholders should keep an eye on Shenzhen Kingkey Smart Agriculture TimesLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Shenzhen Kingkey Smart Agriculture TimesLtd's net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest expense, being 11.3 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Shenzhen Kingkey Smart Agriculture TimesLtd if management cannot prevent a repeat of the 63% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Shenzhen Kingkey Smart Agriculture TimesLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Shenzhen Kingkey Smart Agriculture TimesLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Shenzhen Kingkey Smart Agriculture TimesLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Shenzhen Kingkey Smart Agriculture TimesLtd's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Shenzhen Kingkey Smart Agriculture TimesLtd (of which 2 don't sit too well with us!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.