Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Shenyang Chemical Industry Co., Ltd. (SZSE:000698) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Shenyang Chemical Industry
What Is Shenyang Chemical Industry's Net Debt?
As you can see below, Shenyang Chemical Industry had CN¥2.81b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥1.56b in cash leading to net debt of about CN¥1.25b.
How Strong Is Shenyang Chemical Industry's Balance Sheet?
According to the last reported balance sheet, Shenyang Chemical Industry had liabilities of CN¥3.39b due within 12 months, and liabilities of CN¥1.30b due beyond 12 months. On the other hand, it had cash of CN¥1.56b and CN¥1.01b worth of receivables due within a year. So its liabilities total CN¥2.12b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Shenyang Chemical Industry is worth CN¥3.80b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenyang Chemical Industry's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Shenyang Chemical Industry had a loss before interest and tax, and actually shrunk its revenue by 29%, to CN¥4.9b. That makes us nervous, to say the least.
Caveat Emptor
Not only did Shenyang Chemical Industry's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥742m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥262m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. 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 Shenyang Chemical Industry you should know about.
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.