Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. Importantly, Zhejiang Shibao Company Limited (HKG:1057) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Zhejiang Shibao Carry?
As you can see below, at the end of September 2020, Zhejiang Shibao had CN¥106.9m of debt, up from CN¥72.1m a year ago. Click the image for more detail. But it also has CN¥165.5m in cash to offset that, meaning it has CN¥58.6m net cash.
How Healthy Is Zhejiang Shibao’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zhejiang Shibao had liabilities of CN¥568.0m due within 12 months and liabilities of CN¥51.3m due beyond that. Offsetting this, it had CN¥165.5m in cash and CN¥549.0m in receivables that were due within 12 months. So it can boast CN¥95.3m more liquid assets than total liabilities.
This surplus suggests that Zhejiang Shibao has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Zhejiang Shibao boasts net cash, so it’s fair to say it does not have a heavy debt load! 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 Zhejiang Shibao 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.
In the last year Zhejiang Shibao wasn’t profitable at an EBIT level, but managed to grow its revenue by 17%, to CN¥1.1b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is Zhejiang Shibao?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Zhejiang Shibao had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥42m of cash and made a loss of CN¥103m. But the saving grace is the CN¥58.6m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn’t produce free cash flow regularly. 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 2 warning signs for Zhejiang Shibao (1 doesn’t sit too well with us) 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. 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…