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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shanghai Bailian (Group) Co., Ltd. (SHSE:600827) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Shanghai Bailian (Group)'s Net Debt?
The image below, which you can click on for greater detail, shows that Shanghai Bailian (Group) had debt of CN¥2.58b at the end of December 2023, a reduction from CN¥5.61b over a year. But on the other hand it also has CN¥21.2b in cash, leading to a CN¥18.6b net cash position.
How Strong Is Shanghai Bailian (Group)'s Balance Sheet?
The latest balance sheet data shows that Shanghai Bailian (Group) had liabilities of CN¥25.7b due within a year, and liabilities of CN¥11.0b falling due after that. Offsetting this, it had CN¥21.2b in cash and CN¥1.14b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥14.3b.
This is a mountain of leverage relative to its market capitalization of CN¥14.5b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Shanghai Bailian (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Shanghai Bailian (Group) grew its EBIT by 439% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Shanghai Bailian (Group)'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shanghai Bailian (Group) 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. Happily for any shareholders, Shanghai Bailian (Group) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While Shanghai Bailian (Group) does have more liabilities than liquid assets, it also has net cash of CN¥18.6b. The cherry on top was that in converted 420% of that EBIT to free cash flow, bringing in CN¥2.5b. So we don't have any problem with Shanghai Bailian (Group)'s use of debt. 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. To that end, you should be aware of the 3 warning signs we've spotted with Shanghai Bailian (Group) .
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.