We Think STO ExpressLtd (SZSE:002468) Can Stay On Top Of Its 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.' 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, STO Express Co.,Ltd (SZSE:002468) does carry debt. But should shareholders be worried about its use of debt?

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. 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, 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.

View our latest analysis for STO ExpressLtd

How Much Debt Does STO ExpressLtd Carry?

As you can see below, STO ExpressLtd had CN¥6.02b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥2.47b in cash, and so its net debt is CN¥3.54b.

How Strong Is STO ExpressLtd's Balance Sheet?

The latest balance sheet data shows that STO ExpressLtd had liabilities of CN¥11.1b due within a year, and liabilities of CN¥3.91b falling due after that. On the other hand, it had cash of CN¥2.47b and CN¥1.15b worth of receivables due within a year. So its liabilities total CN¥11.4b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥14.8b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

STO ExpressLtd has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 20.8 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, STO ExpressLtd grew its EBIT by 68% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, STO ExpressLtd reported free cash flow worth 2.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

STO ExpressLtd's interest cover was a real positive on this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about STO ExpressLtd's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of STO ExpressLtd's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.