Is Ningbo Ocean Shipping (SHSE:601022) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Ningbo Ocean Shipping Co., Ltd. (SHSE:601022) makes use of 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ningbo Ocean Shipping

What Is Ningbo Ocean Shipping's Net Debt?

As you can see below, Ningbo Ocean Shipping had CN¥525.7m of debt at September 2023, down from CN¥1.18b a year prior. But it also has CN¥1.62b in cash to offset that, meaning it has CN¥1.10b net cash.

How Strong Is Ningbo Ocean Shipping's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ningbo Ocean Shipping had liabilities of CN¥1.51b due within 12 months and liabilities of CN¥586.8m due beyond that. Offsetting this, it had CN¥1.62b in cash and CN¥1.02b in receivables that were due within 12 months. So it can boast CN¥546.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Ningbo Ocean Shipping could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ningbo Ocean Shipping has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Ningbo Ocean Shipping's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Ningbo Ocean Shipping'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Ningbo Ocean Shipping may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Ningbo Ocean Shipping recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Ningbo Ocean Shipping has net cash of CN¥1.10b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Ningbo Ocean Shipping's balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Ningbo Ocean Shipping that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.