STO ExpressLtd (SZSE:002468) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, '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. Importantly, STO Express Co.,Ltd (SZSE:002468) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for STO ExpressLtd

How Much Debt Does STO ExpressLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 STO ExpressLtd had CN¥6.48b of debt, an increase on CN¥5.41b, over one year. However, it does have CN¥2.92b in cash offsetting this, leading to net debt of about CN¥3.56b.

A Look At STO ExpressLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that STO ExpressLtd had liabilities of CN¥10.9b due within 12 months and liabilities of CN¥3.91b due beyond that. Offsetting these obligations, it had cash of CN¥2.92b as well as receivables valued at CN¥901.4m due within 12 months. So it has liabilities totalling CN¥11.0b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥14.7b, so it does suggest shareholders should keep an eye on STO ExpressLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

STO ExpressLtd's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its commanding EBIT of 14.6 times its interest expense, implies the debt load is as light as a peacock feather. We saw STO ExpressLtd grow its EBIT by 8.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine STO ExpressLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, STO ExpressLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

STO ExpressLtd's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think STO ExpressLtd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Over time, share prices tend to follow earnings per share, so if you're interested in STO ExpressLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.