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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shanghai Milkground Food Tech Co., Ltd (SHSE:600882) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Shanghai Milkground Food Tech Carry?
The image below, which you can click on for greater detail, shows that at December 2023 Shanghai Milkground Food Tech had debt of CN¥1.45b, up from CN¥1.36b in one year. However, its balance sheet shows it holds CN¥2.60b in cash, so it actually has CN¥1.14b net cash.
How Healthy Is Shanghai Milkground Food Tech's Balance Sheet?
According to the last reported balance sheet, Shanghai Milkground Food Tech had liabilities of CN¥1.79b due within 12 months, and liabilities of CN¥737.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.60b as well as receivables valued at CN¥126.6m due within 12 months. So it actually has CN¥192.3m more liquid assets than total liabilities.
This surplus suggests that Shanghai Milkground Food Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Milkground Food Tech has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Shanghai Milkground Food Tech if management cannot prevent a repeat of the 68% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Milkground Food Tech's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Milkground Food Tech 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 Milkground Food Tech saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Milkground Food Tech has net cash of CN¥1.14b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Shanghai Milkground Food Tech's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Shanghai Milkground Food Tech that you should be aware of.
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.