The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Shida Shinghwa Advanced Material Group Co., Ltd. (SHSE:603026) does carry debt. But is this debt a concern to shareholders?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Shida Shinghwa Advanced Material Group Carry?
The image below, which you can click on for greater detail, shows that at March 2024 Shida Shinghwa Advanced Material Group had debt of CN¥2.17b, up from CN¥728.6m in one year. However, because it has a cash reserve of CN¥1.38b, its net debt is less, at about CN¥795.9m.
A Look At Shida Shinghwa Advanced Material Group's Liabilities
According to the last reported balance sheet, Shida Shinghwa Advanced Material Group had liabilities of CN¥2.16b due within 12 months, and liabilities of CN¥1.80b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.38b as well as receivables valued at CN¥976.0m due within 12 months. So it has liabilities totalling CN¥1.61b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Shida Shinghwa Advanced Material Group is worth CN¥7.92b, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shida Shinghwa Advanced Material Group'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.
Over 12 months, Shida Shinghwa Advanced Material Group made a loss at the EBIT level, and saw its revenue drop to CN¥5.4b, which is a fall of 33%. To be frank that doesn't bode well.
Caveat Emptor
While Shida Shinghwa Advanced Material Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥51m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥1.1b in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shida Shinghwa Advanced Material Group (of which 1 shouldn't be ignored!) you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.