Is Shenzhen Easttop Supply Chain Management (SZSE:002889) A Risky Investment?

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, Shenzhen Easttop Supply Chain Management Co., Ltd. (SZSE:002889) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 Shenzhen Easttop Supply Chain Management

How Much Debt Does Shenzhen Easttop Supply Chain Management Carry?

As you can see below, Shenzhen Easttop Supply Chain Management had CN¥1.41b of debt at September 2024, down from CN¥2.14b a year prior. On the flip side, it has CN¥1.09b in cash leading to net debt of about CN¥320.4m.

A Look At Shenzhen Easttop Supply Chain Management's Liabilities

We can see from the most recent balance sheet that Shenzhen Easttop Supply Chain Management had liabilities of CN¥1.81b falling due within a year, and liabilities of CN¥16.8m due beyond that. Offsetting this, it had CN¥1.09b in cash and CN¥1.22b in receivables that were due within 12 months. So it can boast CN¥486.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen Easttop Supply Chain Management could probably pay off its debt with ease, as its balance sheet is far from stretched.

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.

Shenzhen Easttop Supply Chain Management's net debt of 1.6 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.1 times interest expense) certainly does not do anything to dispel this impression. But the other side of the story is that Shenzhen Easttop Supply Chain Management saw its EBIT decline by 9.0% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shenzhen Easttop Supply Chain Management will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Shenzhen Easttop Supply Chain Management created free cash flow amounting to 3.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We weren't impressed with Shenzhen Easttop Supply Chain Management's EBIT growth rate, and its conversion of EBIT to free cash flow made us cautious. Balancing that a bit, it has a demonstrated ability level of total liabilities. Looking at all this data makes us feel a little cautious about Shenzhen Easttop Supply Chain Management's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 - Shenzhen Easttop Supply Chain Management has 2 warning signs we think you should be aware of.

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.