Shenzhen SEGLtd (SZSE:000058) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Shenzhen SEG Co.,Ltd (SZSE:000058) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shenzhen SEGLtd

What Is Shenzhen SEGLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen SEGLtd had CN¥643.8m of debt in September 2024, down from CN¥808.3m, one year before. But it also has CN¥954.4m in cash to offset that, meaning it has CN¥310.7m net cash.

How Strong Is Shenzhen SEGLtd's Balance Sheet?

According to the last reported balance sheet, Shenzhen SEGLtd had liabilities of CN¥1.87b due within 12 months, and liabilities of CN¥710.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥954.4m as well as receivables valued at CN¥466.7m due within 12 months. So its liabilities total CN¥1.16b more than the combination of its cash and short-term receivables.

Since publicly traded Shenzhen SEGLtd shares are worth a total of CN¥10.0b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Shenzhen SEGLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Shenzhen SEGLtd if management cannot prevent a repeat of the 84% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shenzhen SEGLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shenzhen SEGLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Shenzhen SEGLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Shenzhen SEGLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥310.7m. And it impressed us with free cash flow of CN¥299m, being 352% of its EBIT. So we are not troubled with Shenzhen SEGLtd's debt use. 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. Be aware that Shenzhen SEGLtd is showing 1 warning sign in our investment analysis , 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.