These 4 Measures Indicate That Shirble Department Store Holdings (China) (HKG:312) Is Using Debt In A Risky Way

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.' 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. We can see that Shirble Department Store Holdings (China) Limited (HKG:312) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shirble Department Store Holdings (China)

What Is Shirble Department Store Holdings (China)'s Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Shirble Department Store Holdings (China) had CN¥372.1m of debt, an increase on CN¥251.2m, over one year. However, because it has a cash reserve of CN¥365.1m, its net debt is less, at about CN¥6.98m.

How Strong Is Shirble Department Store Holdings (China)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shirble Department Store Holdings (China) had liabilities of CN¥642.0m due within 12 months and liabilities of CN¥1.49b due beyond that. Offsetting these obligations, it had cash of CN¥365.1m as well as receivables valued at CN¥91.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.67b.

The deficiency here weighs heavily on the CN¥800.6m 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, Shirble Department Store Holdings (China) would probably need a major re-capitalization if its creditors were to demand repayment. Shirble Department Store Holdings (China) has a very little net debt but plenty of other liabilities weighing it down.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt at just 0.028 times EBITDA, it seems Shirble Department Store Holdings (China) only uses a little bit of leverage. But EBIT was only 3.4 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. Shareholders should be aware that Shirble Department Store Holdings (China)'s EBIT was down 43% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shirble Department Store Holdings (China)'s earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Shirble Department Store Holdings (China) reported free cash flow worth 2.4% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Shirble Department Store Holdings (China)'s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Shirble Department Store Holdings (China) has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shirble Department Store Holdings (China) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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