China Merchants Shekou Industrial Zone Holdings (SZSE:001979) Has No Shortage Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that China Merchants Shekou Industrial Zone Holdings Co., Ltd. (SZSE:001979) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out 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¥243.3b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥82.9b in cash leading to net debt of about CN¥160.5b.

A Look At China Merchants Shekou Industrial Zone Holdings' Liabilities

The latest balance sheet data shows that China Merchants Shekou Industrial Zone Holdings had liabilities of CN¥426.7b due within a year, and liabilities of CN¥195.4b falling due after that. On the other hand, it had cash of CN¥82.9b and CN¥116.7b worth of receivables due within a year. So its liabilities total CN¥422.5b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥99.1b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Merchants Shekou Industrial Zone Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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.

As it happens China Merchants Shekou Industrial Zone Holdings has a fairly concerning net debt to EBITDA ratio of 11.6 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, China Merchants Shekou Industrial Zone Holdings's EBIT fell a jaw-dropping 33% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. 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 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, China Merchants Shekou Industrial Zone Holdings reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

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. Taking into account all the aforementioned factors, it looks like China Merchants Shekou Industrial Zone Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For example China Merchants Shekou Industrial Zone Holdings has 2 warning signs (and 1 which is significant) we think 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.