Here's Why Shenzhen Feima International Supply Chain (SZSE:002210) Can Manage Its Debt Responsibly

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.' 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 Feima International Supply Chain Co., Ltd. (SZSE:002210) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shenzhen Feima International Supply Chain

How Much Debt Does Shenzhen Feima International Supply Chain Carry?

The chart below, which you can click on for greater detail, shows that Shenzhen Feima International Supply Chain had CN¥606.1m in debt in September 2023; about the same as the year before. On the flip side, it has CN¥84.2m in cash leading to net debt of about CN¥521.9m.

A Look At Shenzhen Feima International Supply Chain's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Feima International Supply Chain had liabilities of CN¥705.0m due within 12 months and liabilities of CN¥373.2m due beyond that. Offsetting these obligations, it had cash of CN¥84.2m as well as receivables valued at CN¥251.2m due within 12 months. So it has liabilities totalling CN¥742.8m more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Feima International Supply Chain shares are worth a total of CN¥4.39b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Shenzhen Feima International Supply Chain has a sky high EBITDA ratio of 7.8, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Shenzhen Feima International Supply Chain is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 550% gain in the last twelve months. 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 Feima International Supply Chain will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Shenzhen Feima International Supply Chain burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Shenzhen Feima International Supply Chain's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble covering its interest expense with its EBIT. Looking at all this data makes us feel a little cautious about Shenzhen Feima International Supply Chain'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 instance, we've identified 1 warning sign for Shenzhen Feima International Supply Chain that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.