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.' 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 Shanghai Ganglian E-Commerce Holdings Co., Ltd. (SZSE:300226) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Shanghai Ganglian E-Commerce Holdings's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Shanghai Ganglian E-Commerce Holdings had debt of CN¥3.15b, up from CN¥2.69b in one year. However, its balance sheet shows it holds CN¥5.67b in cash, so it actually has CN¥2.53b net cash.
A Look At Shanghai Ganglian E-Commerce Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that Shanghai Ganglian E-Commerce Holdings had liabilities of CN¥14.1b due within 12 months and liabilities of CN¥38.2m due beyond that. Offsetting this, it had CN¥5.67b in cash and CN¥1.86b in receivables that were due within 12 months. So it has liabilities totalling CN¥6.62b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of CN¥6.26b, we think shareholders really should watch Shanghai Ganglian E-Commerce Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that Shanghai Ganglian E-Commerce Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
On the other hand, Shanghai Ganglian E-Commerce Holdings saw its EBIT drop by 8.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Ganglian E-Commerce Holdings'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanghai Ganglian E-Commerce 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. Over the last three years, Shanghai Ganglian E-Commerce Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While Shanghai Ganglian E-Commerce Holdings does have more liabilities than liquid assets, it also has net cash of CN¥2.53b. And it impressed us with free cash flow of CN¥677m, being 184% of its EBIT. So we are not troubled with Shanghai Ganglian E-Commerce Holdings's debt use. 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. For example, we've discovered 1 warning sign for Shanghai Ganglian E-Commerce Holdings that you should be aware of before investing here.
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.
