Shenzhou International Group Holdings (HKG:2313) Seems To Use Debt Quite Sensibly

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. We note that Shenzhou International Group Holdings Limited (HKG:2313) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shenzhou International Group Holdings

What Is Shenzhou International Group Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Shenzhou International Group Holdings had CN¥6.61b of debt, an increase on CN¥3.97b, over one year. However, it does have CN¥13.6b in cash offsetting this, leading to net cash of CN¥7.01b.

How Healthy Is Shenzhou International Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhou International Group Holdings had liabilities of CN¥8.85b due within 12 months and liabilities of CN¥728.3m due beyond that. On the other hand, it had cash of CN¥13.6b and CN¥4.17b worth of receivables due within a year. So it actually has CN¥8.20b more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhou International Group Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenzhou International Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Shenzhou International Group Holdings has increased its EBIT by 9.3% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhou International Group Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhou International Group Holdings 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. Looking at the most recent three years, Shenzhou International Group Holdings recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Shenzhou International Group Holdings has CN¥7.01b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 9.3% over the last year. So we are not troubled with Shenzhou International Group Holdings's debt use. We'd be motivated to research the stock further if we found out that Shenzhou International Group Holdings insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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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