Is Shanghai Electric Group (HKG:2727) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Shanghai Electric Group Company Limited (HKG:2727) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Shanghai Electric Group

What Is Shanghai Electric Group's Debt?

The image below, which you can click on for greater detail, shows that Shanghai Electric Group had debt of CN¥37.7b at the end of September 2021, a reduction from CN¥47.8b over a year. However, because it has a cash reserve of CN¥36.2b, its net debt is less, at about CN¥1.55b.

How Strong Is Shanghai Electric Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Electric Group had liabilities of CN¥172.8b due within 12 months and liabilities of CN¥33.0b due beyond that. Offsetting these obligations, it had cash of CN¥36.2b as well as receivables valued at CN¥119.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥50.5b.

This deficit is considerable relative to its very significant market capitalization of CN¥65.9b, so it does suggest shareholders should keep an eye on Shanghai Electric Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Electric Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Shanghai Electric Group wasn't profitable at an EBIT level, but managed to grow its revenue by 10.0%, to CN¥148b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Shanghai Electric Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥4.5b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥9.6b of cash over the last year. So suffice it to say we consider the stock very risky. 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. For example, we've discovered 2 warning signs for Shanghai Electric Group that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.