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 note that Shenzhou International Group Holdings Limited (HKG:2313) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Shenzhou International Group Holdings's Debt?
The image below, which you can click on for greater detail, shows that at December 2018 Shenzhou International Group Holdings had debt of CN¥2.52b, up from CN¥2.13b in one year. But it also has CN¥8.20b in cash to offset that, meaning it has CN¥5.68b net cash.
A Look At Shenzhou International Group Holdings's Liabilities
We can see from the most recent balance sheet that Shenzhou International Group Holdings had liabilities of CN¥4.92b falling due within a year, and liabilities of CN¥178.1m due beyond that. Offsetting this, it had CN¥8.20b in cash and CN¥3.89b in receivables that were due within 12 months. So it can boast CN¥6.99b more liquid assets than total liabilities.
This short term liquidity is a sign that Shenzhou International Group Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenzhou International Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Shenzhou International Group Holdings grew its EBIT at 13% over the last year, further increasing its ability to manage debt. 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 Shenzhou International Group 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, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhou International Group 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 most recent three years, Shenzhou International Group Holdings recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that Shenzhou International Group Holdings has net cash of CN¥5.7b, as well as more liquid assets than liabilities. And it also grew its EBIT by 13% over the last year. So we don't think Shenzhou International Group Holdings's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Shenzhou International Group Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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