Shenzhou International Group Holdings (HKG:2313) Could Easily Take On More Debt

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. We can see that Shenzhou International Group Holdings Limited (HKG:2313) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shenzhou International Group Holdings

What Is Shenzhou International Group Holdings's Debt?

As you can see below, at the end of June 2023, Shenzhou International Group Holdings had CN¥10.8b of debt, up from CN¥9.96b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥13.7b in cash, so it actually has CN¥2.97b net cash.

How Healthy Is Shenzhou International Group Holdings' Balance Sheet?

We can see from the most recent balance sheet that Shenzhou International Group Holdings had liabilities of CN¥11.8b falling due within a year, and liabilities of CN¥2.41b due beyond that. Offsetting this, it had CN¥13.7b in cash and CN¥5.17b in receivables that were due within 12 months. So it actually has CN¥4.72b more liquid assets than total liabilities.

This surplus suggests that Shenzhou International Group Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhou International Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Shenzhou International Group Holdings grew its EBIT at 14% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shenzhou International Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhou International Group Holdings 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. During the last three years, Shenzhou International Group Holdings produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhou International Group Holdings has CN¥2.97b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in CN¥5.8b. So is Shenzhou International Group Holdings's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Shenzhou International Group Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.