Xinji Shaxi Group (HKG:3603) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, '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. Importantly, Xinji Shaxi Group Co., Ltd (HKG:3603) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Xinji Shaxi Group

What Is Xinji Shaxi Group's Net Debt?

As you can see below, at the end of December 2021, Xinji Shaxi Group had CN¥746.4m of debt, up from CN¥630.4m a year ago. Click the image for more detail. On the flip side, it has CN¥249.3m in cash leading to net debt of about CN¥497.1m.

A Look At Xinji Shaxi Group's Liabilities

According to the last reported balance sheet, Xinji Shaxi Group had liabilities of CN¥303.7m due within 12 months, and liabilities of CN¥1.12b due beyond 12 months. Offsetting this, it had CN¥249.3m in cash and CN¥36.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.14b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥250.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Xinji Shaxi Group would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Xinji Shaxi Group has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 4.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even more troubling is the fact that Xinji Shaxi Group actually let its EBIT decrease by 7.2% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Xinji Shaxi 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. In the last three years, Xinji Shaxi Group's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Xinji Shaxi Group's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. We're quite clear that we consider Xinji Shaxi Group to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Xinji Shaxi Group you should be aware of, and 1 of them is concerning.

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.