These 4 Measures Indicate That Shenzhen Kingkey Smart Agriculture TimesLtd (SZSE:000048) Is Using Debt Extensively

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. We can see that Shenzhen Kingkey Smart Agriculture Times Co.,Ltd (SZSE:000048) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Shenzhen Kingkey Smart Agriculture TimesLtd

What Is Shenzhen Kingkey Smart Agriculture TimesLtd's Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Kingkey Smart Agriculture TimesLtd had debt of CN¥2.35b at the end of June 2024, a reduction from CN¥2.58b over a year. On the flip side, it has CN¥597.6m in cash leading to net debt of about CN¥1.75b.

A Look At Shenzhen Kingkey Smart Agriculture TimesLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Kingkey Smart Agriculture TimesLtd had liabilities of CN¥5.94b due within 12 months and liabilities of CN¥1.37b due beyond that. Offsetting this, it had CN¥597.6m in cash and CN¥126.1m in receivables that were due within 12 months. So it has liabilities totalling CN¥6.59b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥7.43b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

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 64% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Shenzhen Kingkey Smart Agriculture TimesLtd'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 we always check how much of that EBIT is translated into free cash flow. During the last two years, Shenzhen Kingkey Smart Agriculture TimesLtd burned a lot of cash. 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

To be frank both Shenzhen Kingkey Smart Agriculture TimesLtd'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. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We're quite clear that we consider Shenzhen Kingkey Smart Agriculture TimesLtd 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. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Shenzhen Kingkey Smart Agriculture TimesLtd (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.