China Shanshui Cement Group (HKG:691) Takes On Some Risk With Its Use 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies China Shanshui Cement Group Limited (HKG:691) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China Shanshui Cement Group

What Is China Shanshui Cement Group's Debt?

The image below, which you can click on for greater detail, shows that China Shanshui Cement Group had debt of CN¥3.97b at the end of December 2020, a reduction from CN¥7.06b over a year. However, because it has a cash reserve of CN¥1.40b, its net debt is less, at about CN¥2.57b.

A Look At China Shanshui Cement Group's Liabilities

According to the last reported balance sheet, China Shanshui Cement Group had liabilities of CN¥9.84b due within 12 months, and liabilities of CN¥1.96b due beyond 12 months. Offsetting this, it had CN¥1.40b in cash and CN¥3.22b in receivables that were due within 12 months. So its liabilities total CN¥7.17b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥7.50b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Shanshui Cement Group's net debt is only 0.38 times its EBITDA. And its EBIT easily covers its interest expense, being 17.2 times the size. So we're pretty relaxed about its super-conservative use of debt. While China Shanshui Cement Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Shanshui Cement Group 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, China Shanshui Cement Group recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Even if we have reservations about how easily China Shanshui Cement Group is capable of staying on top of its total liabilities, its interest cover and net debt to EBITDA make us think feel relatively unconcerned. We think that China Shanshui Cement Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China Shanshui Cement Group's earnings per share history for free.

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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