Is Shenglan Technology (SZSE:300843) Using Too Much 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shenglan Technology Co., Ltd. (SZSE:300843) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shenglan Technology

What Is Shenglan Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shenglan Technology had CN¥390.2m of debt, an increase on CN¥313.9m, over one year. However, it does have CN¥454.4m in cash offsetting this, leading to net cash of CN¥64.1m.

How Healthy Is Shenglan Technology's Balance Sheet?

We can see from the most recent balance sheet that Shenglan Technology had liabilities of CN¥619.5m falling due within a year, and liabilities of CN¥327.7m due beyond that. Offsetting these obligations, it had cash of CN¥454.4m as well as receivables valued at CN¥646.4m due within 12 months. So it actually has CN¥153.6m more liquid assets than total liabilities.

This surplus suggests that Shenglan Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenglan Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Shenglan Technology has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenglan Technology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenglan Technology 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. During the last three years, Shenglan Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenglan Technology has CN¥64.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 39% year-on-year EBIT growth. So we don't have any problem with Shenglan Technology's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Shenglan Technology , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com