Health Check: How Prudently Does China Shenghai Group (HKG:1676) Use Debt?

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.' 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. As with many other companies China Shenghai Group Limited (HKG:1676) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Check out our latest analysis for China Shenghai Group

What Is China Shenghai Group's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 China Shenghai Group had debt of CN¥13.2m, up from CN¥900.0k in one year. However, its balance sheet shows it holds CN¥219.9m in cash, so it actually has CN¥206.6m net cash.

How Healthy Is China Shenghai Group's Balance Sheet?

We can see from the most recent balance sheet that China Shenghai Group had liabilities of CN¥44.9m falling due within a year, and liabilities of CN¥8.47m due beyond that. Offsetting this, it had CN¥219.9m in cash and CN¥133.5m in receivables that were due within 12 months. So it can boast CN¥300.0m more liquid assets than total liabilities.

This surplus liquidity suggests that China Shenghai Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that China Shenghai Group has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Shenghai Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, China Shenghai Group made a loss at the EBIT level, and saw its revenue drop to CN¥163m, which is a fall of 66%. That makes us nervous, to say the least.

So How Risky Is China Shenghai Group?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months China Shenghai Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥25m and booked a CN¥32m accounting loss. Given it only has net cash of CN¥206.6m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. 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 3 warning signs for China Shenghai Group (of which 1 is a bit concerning!) you should know about.

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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This article by Simply Wall St is general in nature. 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.
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