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.' 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 note that Henan Shuanghui Investment & Development Co.,Ltd. (SZSE:000895) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Henan Shuanghui Investment & DevelopmentLtd Carry?
As you can see below, at the end of December 2023, Henan Shuanghui Investment & DevelopmentLtd had CN¥7.00b of debt, up from CN¥3.67b a year ago. Click the image for more detail. On the flip side, it has CN¥6.79b in cash leading to net debt of about CN¥209.5m.
A Look At Henan Shuanghui Investment & DevelopmentLtd's Liabilities
The latest balance sheet data shows that Henan Shuanghui Investment & DevelopmentLtd had liabilities of CN¥14.0b due within a year, and liabilities of CN¥1.51b falling due after that. Offsetting these obligations, it had cash of CN¥6.79b as well as receivables valued at CN¥1.20b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.54b.
Since publicly traded Henan Shuanghui Investment & DevelopmentLtd shares are worth a very impressive total of CN¥95.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Henan Shuanghui Investment & DevelopmentLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Henan Shuanghui Investment & DevelopmentLtd has very modest net debt levels, with net debt at just 0.027 times EBITDA. Humorously, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like an Olympic ice-skater handles a pirouette. But the other side of the story is that Henan Shuanghui Investment & DevelopmentLtd saw its EBIT decline by 4.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Henan Shuanghui Investment & DevelopmentLtd can strengthen its balance sheet over time. 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. 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, Henan Shuanghui Investment & DevelopmentLtd's free cash flow amounted to 38% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
Henan Shuanghui Investment & DevelopmentLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Henan Shuanghui Investment & DevelopmentLtd can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Henan Shuanghui Investment & DevelopmentLtd that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.