Shanghai Industrial Holdings (HKG:363) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Shanghai Industrial Holdings Limited (HKG:363) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Industrial Holdings

How Much Debt Does Shanghai Industrial Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Shanghai Industrial Holdings had debt of HK$60.2b, up from HK$57.5b in one year. On the flip side, it has HK$27.1b in cash leading to net debt of about HK$33.1b.

How Strong Is Shanghai Industrial Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Industrial Holdings had liabilities of HK$41.9b due within 12 months and liabilities of HK$56.6b due beyond that. Offsetting this, it had HK$27.1b in cash and HK$12.9b in receivables that were due within 12 months. So its liabilities total HK$58.5b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$12.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Shanghai Industrial Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shanghai Industrial Holdings's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 6.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. It is well worth noting that Shanghai Industrial Holdings's EBIT shot up like bamboo after rain, gaining 49% in the last twelve months. That'll make it easier to manage its debt. 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 Industrial Holdings'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Shanghai Industrial Holdings's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Shanghai Industrial Holdings's level of total liabilities was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Shanghai Industrial Holdings's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shanghai Industrial Holdings (of which 1 is a bit unpleasant!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.