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. Importantly, Shaanxi Sirui Advanced Materials Co., Ltd. (SHSE:688102) does carry debt. But should shareholders be worried about its use of debt?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Shaanxi Sirui Advanced Materials
The image below, which you can click on for greater detail, shows that at June 2024 Shaanxi Sirui Advanced Materials had debt of CN¥568.6m, up from CN¥340.9m in one year. However, because it has a cash reserve of CN¥130.9m, its net debt is less, at about CN¥437.7m.
According to the last reported balance sheet, Shaanxi Sirui Advanced Materials had liabilities of CN¥462.6m due within 12 months, and liabilities of CN¥359.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥130.9m as well as receivables valued at CN¥345.7m due within 12 months. So its liabilities total CN¥345.0m more than the combination of its cash and short-term receivables.
Of course, Shaanxi Sirui Advanced Materials has a market capitalization of CN¥5.64b, 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.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
We'd say that Shaanxi Sirui Advanced Materials's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its strong interest cover of 23.7 times, makes us even more comfortable. Notably, Shaanxi Sirui Advanced Materials's EBIT launched higher than Elon Musk, gaining a whopping 179% on last year. 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 Shaanxi Sirui Advanced Materials 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual 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.
Based on what we've seen Shaanxi Sirui Advanced Materials is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Shaanxi Sirui Advanced Materials is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Be aware that Shaanxi Sirui Advanced Materials is showing 2 warning signs in our investment analysis , you should know about...
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.