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.' 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 can see that Shanghai Zhonggu Logistics Co., Ltd. (SHSE:603565) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Shanghai Zhonggu Logistics
What Is Shanghai Zhonggu Logistics's Net Debt?
As you can see below, at the end of September 2023, Shanghai Zhonggu Logistics had CN¥7.46b of debt, up from CN¥2.48b a year ago. Click the image for more detail. However, it does have CN¥10.9b in cash offsetting this, leading to net cash of CN¥3.49b.
A Look At Shanghai Zhonggu Logistics' Liabilities
We can see from the most recent balance sheet that Shanghai Zhonggu Logistics had liabilities of CN¥6.04b falling due within a year, and liabilities of CN¥7.55b due beyond that. Offsetting this, it had CN¥10.9b in cash and CN¥671.4m in receivables that were due within 12 months. So its liabilities total CN¥1.98b more than the combination of its cash and short-term receivables.
Given Shanghai Zhonggu Logistics has a market capitalization of CN¥16.0b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shanghai Zhonggu Logistics also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that Shanghai Zhonggu Logistics's load is not too heavy, because its EBIT was down 41% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Zhonggu Logistics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shanghai Zhonggu Logistics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Shanghai Zhonggu Logistics produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
Although Shanghai Zhonggu Logistics's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥3.49b. So we don't have any problem with Shanghai Zhonggu Logistics's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Shanghai Zhonggu Logistics (1 is potentially serious!) that you should be aware of before investing here.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.