Shimao Services Holdings (HKG:873) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Shimao Services Holdings Limited (HKG:873) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Shimao Services Holdings

What Is Shimao Services Holdings's Net Debt?

As you can see below, Shimao Services Holdings had CN¥286.5m of debt at June 2024, down from CN¥437.5m a year prior. But it also has CN¥4.53b in cash to offset that, meaning it has CN¥4.25b net cash.

A Look At Shimao Services Holdings' Liabilities

According to the last reported balance sheet, Shimao Services Holdings had liabilities of CN¥5.41b due within 12 months, and liabilities of CN¥287.3m due beyond 12 months. On the other hand, it had cash of CN¥4.53b and CN¥3.79b worth of receivables due within a year. So it actually has CN¥2.62b more liquid assets than total liabilities.

This surplus liquidity suggests that Shimao Services Holdings' 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 Shimao Services Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Shimao Services Holdings turned things around in the last 12 months, delivering and EBIT of CN¥272m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shimao Services Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shimao Services 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. Happily for any shareholders, Shimao Services Holdings actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shimao Services Holdings has CN¥4.25b in net cash and a strong balance sheet. And it impressed us with free cash flow of CN¥380m, being 140% of its EBIT. So we don't think Shimao Services Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Shimao Services Holdings that you should be aware of before investing here.

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.