Shenzhou International Group Holdings (HKG:2313) Seems To Use Debt Rather Sparingly

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.' 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. We note that Shenzhou International Group Holdings Limited (HKG:2313) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for Shenzhou International Group Holdings

How Much Debt Does Shenzhou International Group Holdings Carry?

As you can see below, Shenzhou International Group Holdings had CN¥9.20b of debt at December 2022, down from CN¥10.6b a year prior. But it also has CN¥13.7b in cash to offset that, meaning it has CN¥4.54b net cash.

A Look At Shenzhou International Group Holdings' Liabilities

We can see from the most recent balance sheet that Shenzhou International Group Holdings had liabilities of CN¥10.3b falling due within a year, and liabilities of CN¥2.47b due beyond that. On the other hand, it had cash of CN¥13.7b and CN¥5.21b worth of receivables due within a year. So it can boast CN¥6.22b 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. 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.

And we also note warmly that Shenzhou International Group Holdings grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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 63% 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 we empathize with investors who find debt concerning, you should keep in mind that Shenzhou International Group Holdings has net cash of CN¥4.54b, as well as more liquid assets than liabilities. So we don't think Shenzhou International Group Holdings's use of debt is risky. 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. Be aware that Shenzhou International Group Holdings is showing 1 warning sign in our investment analysis , 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.