Shanghai Fortune Techgroup (SZSE:300493) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Shanghai Fortune Techgroup Co., Ltd. (SZSE:300493) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Shanghai Fortune Techgroup

What Is Shanghai Fortune Techgroup's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Fortune Techgroup had CN¥150.3m of debt, an increase on CN¥87.1m, over one year. However, its balance sheet shows it holds CN¥272.6m in cash, so it actually has CN¥122.3m net cash.

A Look At Shanghai Fortune Techgroup's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Fortune Techgroup had liabilities of CN¥752.2m due within 12 months 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 can boast 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!

The modesty of its debt load may become crucial for Shanghai Fortune Techgroup if management cannot prevent a repeat of the 31% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Fortune Techgroup can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. In the last three years, Shanghai Fortune Techgroup created free cash flow amounting to 3.4% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down 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. 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. For example Shanghai Fortune Techgroup has 2 warning signs (and 1 which can't be ignored) we think 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.