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, Shenzhou International Group Holdings Limited (HKG:2313) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
See our latest analysis for Shenzhou International Group Holdings
How Much Debt Does Shenzhou International Group Holdings Carry?
The image below, which you can click on for greater detail, shows that at December 2021 Shenzhou International Group Holdings had debt of CN¥10.6b, up from CN¥6.61b in one year. However, its balance sheet shows it holds CN¥12.2b in cash, so it actually has CN¥1.57b net cash.
A Look At Shenzhou International Group Holdings’ Liabilities
According to the last reported balance sheet, Shenzhou International Group Holdings had liabilities of CN¥13.5b due within 12 months, and liabilities of CN¥816.4m due beyond 12 months. Offsetting this, it had CN¥12.2b in cash and CN¥3.92b in receivables that were due within 12 months. So it can boast CN¥1.74b more liquid assets than total liabilities.
This state of affairs indicates that Shenzhou International Group Holdings’ balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it’s very unlikely that the CN¥135.3b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Shenzhou International Group Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Shenzhou International Group Holdings if management cannot prevent a repeat of the 34% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhou International Group 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shenzhou International Group 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. During the last three years, Shenzhou International Group Holdings produced sturdy free cash flow equating to 57% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Shenzhou International Group Holdings has net cash of CN¥1.57b, as well as more liquid assets than liabilities. So we are not troubled with Shenzhou International Group Holdings’s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 1 warning sign for Shenzhou International Group Holdings that you should be aware of.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
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