Is Shanghai Fortune Techgroup (SZSE:300493) Using Too Much Debt?

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, Shanghai Fortune Techgroup Co., Ltd. (SZSE:300493) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Fortune Techgroup

How Much Debt Does Shanghai Fortune Techgroup Carry?

As you can see below, at the end of September 2024, Shanghai Fortune Techgroup had CN¥150.3m of debt, up from CN¥87.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥272.6m in cash, so it actually has CN¥122.3m net cash.

How Healthy Is Shanghai Fortune Techgroup's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Fortune Techgroup had liabilities of CN¥752.2m falling due within a year, and liabilities of CN¥25.9m due beyond that. Offsetting this, it had CN¥272.6m in cash and CN¥951.5m in receivables that were due within 12 months. So it actually has CN¥446.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Fortune Techgroup could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Fortune Techgroup boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shanghai Fortune Techgroup's saving grace is its low debt levels, because its EBIT has tanked 31% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Shanghai Fortune Techgroup 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. Shanghai Fortune Techgroup may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shanghai Fortune Techgroup reported free cash flow worth 3.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Fortune Techgroup has CN¥122.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Shanghai Fortune Techgroup's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shanghai Fortune Techgroup is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.