Shenzhen Kingdom Sci-Tech (SHSE:600446) Seems To Use Debt Quite Sensibly

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 Shenzhen Kingdom Sci-Tech Co., Ltd (SHSE:600446) does use debt in its business. But should shareholders be worried about its use of debt?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shenzhen Kingdom Sci-Tech

What Is Shenzhen Kingdom Sci-Tech's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shenzhen Kingdom Sci-Tech had CN¥1.55b of debt, an increase on CN¥1.20b, over one year. But it also has CN¥1.95b in cash to offset that, meaning it has CN¥406.4m net cash.

A Look At Shenzhen Kingdom Sci-Tech's Liabilities

We can see from the most recent balance sheet that Shenzhen Kingdom Sci-Tech had liabilities of CN¥3.05b falling due within a year, and liabilities of CN¥51.3m due beyond that. On the other hand, it had cash of CN¥1.95b and CN¥1.61b worth of receivables due within a year. So it actually has CN¥460.7m more liquid assets than total liabilities.

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

In fact Shenzhen Kingdom Sci-Tech's saving grace is its low debt levels, because its EBIT has tanked 49% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Shenzhen Kingdom Sci-Tech 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. While Shenzhen Kingdom Sci-Tech 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. Over the last three years, Shenzhen Kingdom Sci-Tech recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Kingdom Sci-Tech has CN¥406.4m in net cash and a decent-looking balance sheet. So we are not troubled with Shenzhen Kingdom Sci-Tech's debt use. 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 Shenzhen Kingdom Sci-Tech is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.