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. We note that Shaanxi Sirui Advanced Materials Co., Ltd. (SHSE:688102) does have debt on its balance sheet. 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. 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 Shaanxi Sirui Advanced Materials Carry?
As you can see below, at the end of September 2023, Shaanxi Sirui Advanced Materials had CN¥356.1m of debt, up from CN¥255.7m a year ago. Click the image for more detail. However, it does have CN¥74.9m in cash offsetting this, leading to net debt of about CN¥281.2m.
A Look At Shaanxi Sirui Advanced Materials' Liabilities
According to the last reported balance sheet, Shaanxi Sirui Advanced Materials had liabilities of CN¥346.2m due within 12 months, and liabilities of CN¥241.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥74.9m as well as receivables valued at CN¥320.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥192.3m.
Since publicly traded Shaanxi Sirui Advanced Materials shares are worth a total of CN¥6.01b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Shaanxi Sirui Advanced Materials's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its commanding EBIT of 11.1 times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Shaanxi Sirui Advanced Materials is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 100% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shaanxi Sirui Advanced Materials'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shaanxi Sirui Advanced Materials burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
The good news is that Shaanxi Sirui Advanced Materials's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Shaanxi Sirui Advanced Materials can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. To that end, you should be aware of the 1 warning sign we've spotted with Shaanxi Sirui Advanced Materials .
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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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.