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. Importantly, Beijing Shenzhou Aerospace Software Technology Co., ltd (SHSE:688562) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Beijing Shenzhou Aerospace Software Technology Carry?
As you can see below, at the end of September 2023, Beijing Shenzhou Aerospace Software Technology had CN¥17.4m of debt, up from CN¥16.3m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.53b in cash, leading to a CN¥1.51b net cash position.
How Strong Is Beijing Shenzhou Aerospace Software Technology's Balance Sheet?
The latest balance sheet data shows that Beijing Shenzhou Aerospace Software Technology had liabilities of CN¥1.38b due within a year, and liabilities of CN¥214.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.53b as well as receivables valued at CN¥561.3m due within 12 months. So it actually has CN¥497.5m more liquid assets than total liabilities.
This surplus suggests that Beijing Shenzhou Aerospace Software Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Beijing Shenzhou Aerospace Software Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Beijing Shenzhou Aerospace Software Technology grew its EBIT by 87% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Beijing Shenzhou Aerospace Software Technology 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Beijing Shenzhou Aerospace Software Technology 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 three years, Beijing Shenzhou Aerospace Software Technology 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 it is always sensible to investigate a company's debt, in this case Beijing Shenzhou Aerospace Software Technology has CN¥1.51b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in -CN¥209m. So we don't think Beijing Shenzhou Aerospace Software Technology's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Beijing Shenzhou Aerospace Software Technology, you may well want to click here to check an interactive graph of its earnings per share history.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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