Warren Buffett famously said, '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 China Shanshui Cement Group Limited (HKG:691) makes use of debt.  But is this debt a concern to shareholders?

When Is Debt A Problem?

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.  In the worst case scenario, a company can go bankrupt if it cannot pay its creditors.  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.  When we think about a company's use of debt, we first look at cash and debt together.

What Is China Shanshui Cement Group's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 China Shanshui Cement Group had debt of CN¥5.13b, up from CN¥4.51b in one year.    However, it also had CN¥2.77b in cash, and so its net debt is CN¥2.37b.  

SEHK:691 Debt to Equity History March 26th 2024

How Healthy Is China Shanshui Cement Group's Balance Sheet?

According to the last reported balance sheet, China Shanshui Cement Group had liabilities of CN¥10.7b due within 12 months, and liabilities of CN¥1.63b due beyond 12 months.   Offsetting these obligations, it had cash of CN¥2.77b as well as receivables valued at CN¥1.85b due within 12 months.   So it has liabilities totalling CN¥7.76b more than its cash and near-term receivables, combined.  

This deficit casts a shadow over the CN¥2.53b company, like a colossus towering over mere mortals.   So we'd watch its balance sheet closely, without a doubt.  After all, China Shanshui Cement Group would likely require a major re-capitalisation if it had to pay its creditors today.  

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover).  This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

China Shanshui Cement Group has a very low debt to EBITDA ratio of 1.5 so it is strange to see weak interest coverage, with last year's EBIT being only 1.7 times the interest expense.  So one way or the other, it's clear the debt levels are not trivial.        Shareholders should be aware that China Shanshui Cement Group's EBIT was down 90% last year.   If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster.      When analysing debt levels, the balance sheet is the obvious place to start.  But you can't view debt in total isolation; since China Shanshui Cement Group will need earnings to service that debt.  So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits.   So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow.    In the last three years, China Shanshui Cement Group created free cash flow amounting to 7.4% of its EBIT, an uninspiring performance.  That limp level of cash conversion undermines its ability to manage and pay down debt.  

Our View

To be frank both China Shanshui Cement Group's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels.    But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic.      After considering the datapoints discussed, we think China Shanshui Cement Group has too much debt.  That sort of riskiness is ok for some, but it certainly doesn't float our boat.    There's no doubt that we learn most about debt from the balance sheet.  However, not all investment risk resides within the balance sheet - far from it.   Case in point: We've spotted   2 warning signs for China Shanshui Cement Group  you should be aware of, and 1 of them is significant.    

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.