Shandong Hi-speed (SHSE:600350) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Shandong Hi-speed Company Limited (SHSE:600350) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shandong Hi-speed

What Is Shandong Hi-speed's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shandong Hi-speed had CN¥74.0b of debt, an increase on CN¥67.3b, over one year. However, because it has a cash reserve of CN¥6.51b, its net debt is less, at about CN¥67.5b.

How Healthy Is Shandong Hi-speed's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shandong Hi-speed had liabilities of CN¥33.4b due within 12 months and liabilities of CN¥68.2b due beyond that. Offsetting these obligations, it had cash of CN¥6.51b as well as receivables valued at CN¥13.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥81.9b.

The deficiency here weighs heavily on the CN¥46.7b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Shandong Hi-speed would likely require a major re-capitalisation if it had to pay its creditors today.

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).

As it happens Shandong Hi-speed has a fairly concerning net debt to EBITDA ratio of 7.0 but very strong interest coverage of 19.1. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Sadly, Shandong Hi-speed's EBIT actually dropped 9.9% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Shandong Hi-speed can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shandong Hi-speed 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.

Our View

To be frank both Shandong Hi-speed's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that Shandong Hi-speed is in the Infrastructure industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like Shandong Hi-speed has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shandong Hi-speed (of which 1 is significant!) you should know about.

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.