We Think Shanghai Electric Group (HKG:2727) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shanghai Electric Group Co., Ltd. (HKG:2727) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shanghai Electric Group

What Is Shanghai Electric Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Shanghai Electric Group had CN¥47.0b of debt, an increase on CN¥39.1b, over one year. But on the other hand it also has CN¥50.2b in cash, leading to a CN¥3.20b net cash position.

How Strong Is Shanghai Electric Group's Balance Sheet?

The latest balance sheet data shows that Shanghai Electric Group had liabilities of CN¥167.7b due within a year, and liabilities of CN¥38.6b falling due after that. On the other hand, it had cash of CN¥50.2b and CN¥95.8b worth of receivables due within a year. So its liabilities total CN¥60.3b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥62.1b, so it does suggest shareholders should keep an eye on Shanghai Electric Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Shanghai Electric Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Shanghai Electric Group turned things around in the last 12 months, delivering and EBIT of CN¥1.4b. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Electric Group 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. Happily for any shareholders, Shanghai Electric Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Shanghai Electric Group does have more liabilities than liquid assets, it also has net cash of CN¥3.20b. And it impressed us with free cash flow of CN¥3.6b, being 257% of its EBIT. So we don't have any problem with Shanghai Electric Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Shanghai Electric Group , and understanding them should be part of your investment process.

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.