Does Zhongshen Jianye Holding (HKG:2503) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Zhongshen Jianye Holding Limited (HKG:2503) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zhongshen Jianye Holding

How Much Debt Does Zhongshen Jianye Holding Carry?

As you can see below, at the end of June 2024, Zhongshen Jianye Holding had CN¥27.8m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥185.8m in cash, so it actually has CN¥158.0m net cash.

How Strong Is Zhongshen Jianye Holding's Balance Sheet?

We can see from the most recent balance sheet that Zhongshen Jianye Holding had liabilities of CN¥1.04b falling due within a year, and liabilities of CN¥24.8m due beyond that. Offsetting this, it had CN¥185.8m in cash and CN¥1.27b in receivables that were due within 12 months. So it can boast CN¥392.4m more liquid assets than total liabilities.

This surplus strongly suggests that Zhongshen Jianye Holding has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Zhongshen Jianye Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Zhongshen Jianye Holding if management cannot prevent a repeat of the 44% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Zhongshen Jianye Holding's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhongshen Jianye Holding 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. Looking at the most recent three years, Zhongshen Jianye Holding recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Zhongshen Jianye Holding has net cash of CN¥158.0m and plenty of liquid assets. So we don't have any problem with Zhongshen Jianye Holding'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. Be aware that Zhongshen Jianye Holding is showing 4 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.