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, Shanghai Zhangjiang Hi-Tech Park Development Co., Ltd. (SHSE:600895) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Shanghai Zhangjiang Hi-Tech Park Development Carry?
As you can see below, at the end of March 2024, Shanghai Zhangjiang Hi-Tech Park Development had CN¥27.9b of debt, up from CN¥23.0b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥2.81b, its net debt is less, at about CN¥25.1b.
How Healthy Is Shanghai Zhangjiang Hi-Tech Park Development's Balance Sheet?
We can see from the most recent balance sheet that Shanghai Zhangjiang Hi-Tech Park Development had liabilities of CN¥16.6b falling due within a year, and liabilities of CN¥19.5b due beyond that. Offsetting these obligations, it had cash of CN¥2.81b as well as receivables valued at CN¥287.1m due within 12 months. So it has liabilities totalling CN¥33.0b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of CN¥30.4b, we think shareholders really should watch Shanghai Zhangjiang Hi-Tech Park Development'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.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Shanghai Zhangjiang Hi-Tech Park Development has a rather high debt to EBITDA ratio of 16.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.1 times, suggesting it can responsibly service its obligations. The silver lining is that Shanghai Zhangjiang Hi-Tech Park Development grew its EBIT by 254% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Zhangjiang Hi-Tech Park Development'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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shanghai Zhangjiang Hi-Tech Park Development burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
To be frank both Shanghai Zhangjiang Hi-Tech Park Development's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Shanghai Zhangjiang Hi-Tech Park Development's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Shanghai Zhangjiang Hi-Tech Park Development (including 1 which is a bit unpleasant) .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.