Here's Why Zhejiang Shibao (HKG:1057) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Zhejiang Shibao Company Limited (HKG:1057) 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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Zhejiang Shibao

What Is Zhejiang Shibao's Net Debt?

As you can see below, at the end of June 2023, Zhejiang Shibao had CN¥222.0m of debt, up from CN¥111.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥274.4m in cash, so it actually has CN¥52.4m net cash.

How Strong Is Zhejiang Shibao's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhejiang Shibao had liabilities of CN¥945.7m due within 12 months and liabilities of CN¥73.1m due beyond that. On the other hand, it had cash of CN¥274.4m and CN¥676.5m worth of receivables due within a year. So its liabilities total CN¥68.0m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Zhejiang Shibao's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥8.41b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Zhejiang Shibao boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Zhejiang Shibao improved its EBIT from a last year's loss to a positive CN¥15m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zhejiang Shibao 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhejiang Shibao 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. During the last year, Zhejiang Shibao burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

We could understand if investors are concerned about Zhejiang Shibao's liabilities, but we can be reassured by the fact it has has net cash of CN¥52.4m. So we don't have any problem with Zhejiang Shibao's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Zhejiang Shibao .

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.