China Sanjiang Fine Chemicals (HKG:2198) Has No Shortage Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 China Sanjiang Fine Chemicals Company Limited (HKG:2198) does use debt in its business. But is this debt a concern to shareholders?

We've discovered 2 warning signs about China Sanjiang Fine Chemicals. View them for free.

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is China Sanjiang Fine Chemicals's Net Debt?

As you can see below, at the end of December 2024, China Sanjiang Fine Chemicals had CN¥10.9b of debt, up from CN¥10.2b a year ago. Click the image for more detail. However, it does have CN¥888.8m in cash offsetting this, leading to net debt of about CN¥10.1b.

How Strong Is China Sanjiang Fine Chemicals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Sanjiang Fine Chemicals had liabilities of CN¥13.7b due within 12 months and liabilities of CN¥3.52b due beyond that. Offsetting these obligations, it had cash of CN¥888.8m as well as receivables valued at CN¥2.26b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥14.1b.

This deficit casts a shadow over the CN¥2.06b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Sanjiang Fine Chemicals would probably need a major re-capitalization if its creditors were to demand repayment.

View our latest analysis for China Sanjiang Fine Chemicals

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 7.4 hit our confidence in China Sanjiang Fine Chemicals like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for China Sanjiang Fine Chemicals is that it turned last year's EBIT loss into a gain of CN¥808m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Sanjiang Fine Chemicals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Considering the last year, China Sanjiang Fine Chemicals actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both China Sanjiang Fine Chemicals's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like China Sanjiang Fine Chemicals has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with China Sanjiang Fine Chemicals .

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. 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.