China Merchants Shekou Industrial Zone Holdings (SZSE:001979) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, China Merchants Shekou Industrial Zone Holdings Co., Ltd. (SZSE:001979) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China Merchants Shekou Industrial Zone Holdings

How Much Debt Does China Merchants Shekou Industrial Zone Holdings Carry?

As you can see below, China Merchants Shekou Industrial Zone Holdings had CN¥207.1b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥88.9b in cash leading to net debt of about CN¥118.2b.

How Strong Is China Merchants Shekou Industrial Zone Holdings' Balance Sheet?

The latest balance sheet data shows that China Merchants Shekou Industrial Zone Holdings had liabilities of CN¥485.4b due within a year, and liabilities of CN¥181.7b falling due after that. Offsetting this, it had CN¥88.9b in cash and CN¥135.8b in receivables that were due within 12 months. So it has liabilities totalling CN¥442.4b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥83.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Merchants Shekou Industrial Zone Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strangely China Merchants Shekou Industrial Zone Holdings has a sky high EBITDA ratio of 6.5, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Shareholders should be aware that China Merchants Shekou Industrial Zone Holdings's EBIT was down 29% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 China Merchants Shekou Industrial Zone Holdings can strengthen its balance sheet over time. 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. Happily for any shareholders, China Merchants Shekou Industrial Zone Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, China Merchants Shekou Industrial Zone Holdings's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that China Merchants Shekou Industrial Zone Holdings's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Merchants Shekou Industrial Zone Holdings is showing 3 warning signs 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.

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.