Is COSCO SHIPPING Specialized CarriersLtd (SHSE:600428) Using Too Much Debt?

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.' 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. Importantly, COSCO SHIPPING Specialized Carriers Co.,Ltd. (SHSE:600428) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for COSCO SHIPPING Specialized CarriersLtd

What Is COSCO SHIPPING Specialized CarriersLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 COSCO SHIPPING Specialized CarriersLtd had CN¥7.43b of debt, an increase on CN¥6.84b, over one year. However, it does have CN¥1.34b in cash offsetting this, leading to net debt of about CN¥6.09b.

How Strong Is COSCO SHIPPING Specialized CarriersLtd's Balance Sheet?

The latest balance sheet data shows that COSCO SHIPPING Specialized CarriersLtd had liabilities of CN¥5.63b due within a year, and liabilities of CN¥10.4b falling due after that. Offsetting these obligations, it had cash of CN¥1.34b as well as receivables valued at CN¥1.73b due within 12 months. So it has liabilities totalling CN¥13.0b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥14.4b, so it does suggest shareholders should keep an eye on COSCO SHIPPING Specialized CarriersLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

COSCO SHIPPING Specialized CarriersLtd's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 4.2 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, COSCO SHIPPING Specialized CarriersLtd saw its EBIT tank 38% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 COSCO SHIPPING Specialized CarriersLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, COSCO SHIPPING Specialized CarriersLtd recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Mulling over COSCO SHIPPING Specialized CarriersLtd's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that COSCO SHIPPING Specialized CarriersLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 3 warning signs for COSCO SHIPPING Specialized CarriersLtd that you should be aware of before investing here.

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.

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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.