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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sanjiang Shopping Club Co.,Ltd (SHSE:601116) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Sanjiang Shopping ClubLtd
What Is Sanjiang Shopping ClubLtd's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2023 Sanjiang Shopping ClubLtd had debt of CN¥350.5m, up from none in one year. However, it does have CN¥652.6m in cash offsetting this, leading to net cash of CN¥302.0m.
A Look At Sanjiang Shopping ClubLtd's Liabilities
We can see from the most recent balance sheet that Sanjiang Shopping ClubLtd had liabilities of CN¥1.61b falling due within a year, and liabilities of CN¥274.5m due beyond that. Offsetting this, it had CN¥652.6m in cash and CN¥54.2m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.17b more than its cash and near-term receivables, combined.
Of course, Sanjiang Shopping ClubLtd has a market capitalization of CN¥8.08b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sanjiang Shopping ClubLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Sanjiang Shopping ClubLtd grew its EBIT by 131% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sanjiang Shopping ClubLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sanjiang Shopping ClubLtd 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. Over the last two years, Sanjiang Shopping ClubLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While Sanjiang Shopping ClubLtd does have more liabilities than liquid assets, it also has net cash of CN¥302.0m. The cherry on top was that in converted 304% of that EBIT to free cash flow, bringing in CN¥249m. So is Sanjiang Shopping ClubLtd's debt a risk? It doesn't seem so to us. 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 - Sanjiang Shopping ClubLtd has 1 warning sign we think you should be aware of.
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.