Here's Why Shanghai @hubLtd (SHSE:603881) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shanghai @hub Co.,Ltd. (SHSE:603881) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 @hubLtd

How Much Debt Does Shanghai @hubLtd Carry?

The image below, which you can click on for greater detail, shows that Shanghai @hubLtd had debt of CN¥2.54b at the end of March 2024, a reduction from CN¥3.26b over a year. However, it does have CN¥1.06b in cash offsetting this, leading to net debt of about CN¥1.49b.

How Strong Is Shanghai @hubLtd's Balance Sheet?

We can see from the most recent balance sheet that Shanghai @hubLtd had liabilities of CN¥1.95b falling due within a year, and liabilities of CN¥2.09b due beyond that. Offsetting these obligations, it had cash of CN¥1.06b as well as receivables valued at CN¥644.4m due within 12 months. So its liabilities total CN¥2.34b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shanghai @hubLtd has a market capitalization of CN¥7.86b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.5 and interest cover of 2.5 times, it seems to us that Shanghai @hubLtd is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Unfortunately, Shanghai @hubLtd saw its EBIT slide 4.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai @hubLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, Shanghai @hubLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

When it comes to the balance sheet, the standout positive for Shanghai @hubLtd was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. In particular, interest cover gives us cold feet. Considering this range of data points, we think Shanghai @hubLtd is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Shanghai @hubLtd , and understanding them should be part of your investment process.

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.

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