Stock Analysis

Is China Shenshan Orchard Holdings (SGX:BKV) Using Too Much Debt?

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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.' 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. We note that China Shenshan Orchard Holdings Co. Ltd. (SGX:BKV) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for China Shenshan Orchard Holdings

What Is China Shenshan Orchard Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Shenshan Orchard Holdings had CN¥13.6m of debt in December 2022, down from CN¥18.0m, one year before. However, it does have CN¥126.0m in cash offsetting this, leading to net cash of CN¥112.4m.

SGX:BKV Debt to Equity History May 12th 2023

How Strong Is China Shenshan Orchard Holdings' Balance Sheet?

According to the last reported balance sheet, China Shenshan Orchard Holdings had liabilities of CN¥30.0m due within 12 months, and liabilities of CN¥246.9m due beyond 12 months. Offsetting this, it had CN¥126.0m in cash and CN¥40.4m in receivables that were due within 12 months. So its liabilities total CN¥110.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥62.4m 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. After all, China Shenshan Orchard Holdings would likely require a major re-capitalisation if it had to pay its creditors today. China Shenshan Orchard Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

It was also good to see that despite losing money on the EBIT line last year, China Shenshan Orchard Holdings turned things around in the last 12 months, delivering and EBIT of CN¥20m. 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 Shenshan Orchard Holdings 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. While China Shenshan Orchard Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, China Shenshan Orchard Holdings actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although China Shenshan Orchard Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥112.4m. And it impressed us with free cash flow of CN¥52m, being 260% of its EBIT. So although we see some areas for improvement, we're not too worried about China Shenshan Orchard Holdings's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for China Shenshan Orchard Holdings (1 is a bit concerning) you should be aware of.

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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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.