Zhejiang Shibao (HKG:1057) Seems To Use Debt Quite Sensibly

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. As with many other companies Zhejiang Shibao Company Limited (HKG:1057) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Shibao

How Much Debt Does Zhejiang Shibao Carry?

You can click the graphic below for the historical numbers, but it shows that Zhejiang Shibao had CN¥106.9m of debt in March 2021, down from CN¥159.1m, one year before. However, its balance sheet shows it holds CN¥192.6m in cash, so it actually has CN¥85.7m net cash.

How Healthy Is Zhejiang Shibao's Balance Sheet?

According to the last reported balance sheet, Zhejiang Shibao had liabilities of CN¥558.6m due within 12 months, and liabilities of CN¥54.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥192.6m as well as receivables valued at CN¥507.7m due within 12 months. So it can boast CN¥87.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Shibao could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Zhejiang Shibao boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Zhejiang Shibao made a loss at the EBIT level, last year, it was also good to see that it generated CN¥41m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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. While Zhejiang Shibao has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last year, Zhejiang Shibao's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Shibao has net cash of CN¥85.7m, as well as more liquid assets than liabilities. So we don't have any problem with Zhejiang Shibao's use of debt. 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 Zhejiang Shibao has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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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