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 can see that COSCO SHIPPING Specialized Carriers Co.,Ltd. (SHSE:600428) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is COSCO SHIPPING Specialized CarriersLtd's Debt?

As you can see below, at the end of September 2024, COSCO SHIPPING Specialized CarriersLtd had CN¥7.69b of debt, up from CN¥6.81b a year ago. Click the image for more detail. However, it also had CN¥2.22b in cash, and so its net debt is CN¥5.48b.

How Healthy Is COSCO SHIPPING Specialized CarriersLtd's Balance Sheet?

We can see from the most recent balance sheet that COSCO SHIPPING Specialized CarriersLtd had liabilities of CN¥8.47b falling due within a year, and liabilities of CN¥11.4b due beyond that. Offsetting these obligations, it had cash of CN¥2.22b as well as receivables valued at CN¥2.12b due within 12 months. So its liabilities total CN¥15.5b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥15.2b, we think shareholders really should watch COSCO SHIPPING Specialized CarriersLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

COSCO SHIPPING Specialized CarriersLtd's net debt of 2.1 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.2 times interest expense) certainly does not do anything to dispel this impression. Importantly, COSCO SHIPPING Specialized CarriersLtd grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine COSCO SHIPPING Specialized CarriersLtd's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, COSCO SHIPPING Specialized CarriersLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that COSCO SHIPPING Specialized CarriersLtd's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we must concede we find its level of total liabilities has the opposite effect. Looking at all the aforementioned factors together, it strikes us that COSCO SHIPPING Specialized CarriersLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. To that end, you should be aware of the 3 warning signs we've spotted with COSCO SHIPPING Specialized CarriersLtd .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.