Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shandong Longda Meishi Co., Ltd. (SZSE:002726) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Shandong Longda Meishi
How Much Debt Does Shandong Longda Meishi Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shandong Longda Meishi had CN¥2.76b of debt, an increase on CN¥2.37b, over one year. However, because it has a cash reserve of CN¥1.36b, its net debt is less, at about CN¥1.40b.
How Healthy Is Shandong Longda Meishi's Balance Sheet?
We can see from the most recent balance sheet that Shandong Longda Meishi had liabilities of CN¥3.40b falling due within a year, and liabilities of CN¥1.28b due beyond that. Offsetting these obligations, it had cash of CN¥1.36b as well as receivables valued at CN¥555.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.76b.
While this might seem like a lot, it is not so bad since Shandong Longda Meishi has a market capitalization of CN¥9.39b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shandong Longda Meishi'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.
In the last year Shandong Longda Meishi had a loss before interest and tax, and actually shrunk its revenue by 4.3%, to CN¥15b. That's not what we would hope to see.
Caveat Emptor
Importantly, Shandong Longda Meishi had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥208m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥1.0b of cash over the last year. So in short it's a really risky stock. 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. Be aware that Shandong Longda Meishi is showing 1 warning sign in our investment analysis , you should know about...
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.