We Think CIG ShangHai (SHSE:603083) Can Stay On Top Of Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that CIG ShangHai Co., Ltd. (SHSE:603083) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is CIG ShangHai's Debt?

The image below, which you can click on for greater detail, shows that CIG ShangHai had debt of CN¥962.9m at the end of September 2024, a reduction from CN¥1.24b over a year. However, it does have CN¥351.4m in cash offsetting this, leading to net debt of about CN¥611.5m.

A Look At CIG ShangHai's Liabilities

The latest balance sheet data shows that CIG ShangHai had liabilities of CN¥2.16b due within a year, and liabilities of CN¥245.8m falling due after that. Offsetting these obligations, it had cash of CN¥351.4m as well as receivables valued at CN¥1.23b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥825.6m.

Given CIG ShangHai has a market capitalization of CN¥10.3b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

View our latest analysis for CIG ShangHai

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

CIG ShangHai has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 3.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Worse, CIG ShangHai's EBIT was down 42% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CIG ShangHai will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, CIG ShangHai produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

CIG ShangHai's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about CIG ShangHai's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. We've identified 2 warning signs with CIG ShangHai , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.