Here's Why Shengda ResourcesLtd (SZSE:000603) Can Manage Its Debt Responsibly

Simply Wall St · 10/18 22:18

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shengda Resources Co.,Ltd. (SZSE:000603) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shengda ResourcesLtd

How Much Debt Does Shengda ResourcesLtd Carry?

As you can see below, Shengda ResourcesLtd had CN¥1.12b of debt at June 2024, down from CN¥1.21b a year prior. However, because it has a cash reserve of CN¥866.7m, its net debt is less, at about CN¥252.9m.

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SZSE:000603 Debt to Equity History October 18th 2024

How Healthy Is Shengda ResourcesLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shengda ResourcesLtd had liabilities of CN¥1.92b due within 12 months and liabilities of CN¥725.5m due beyond that. Offsetting this, it had CN¥866.7m in cash and CN¥659.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.12b.

Of course, Shengda ResourcesLtd has a market capitalization of CN¥9.30b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shengda ResourcesLtd has a low net debt to EBITDA ratio of only 0.48. And its EBIT easily covers its interest expense, being 20.0 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Shengda ResourcesLtd's saving grace is its low debt levels, because its EBIT has tanked 41% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shengda ResourcesLtd'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 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, Shengda ResourcesLtd generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Shengda ResourcesLtd'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 the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Shengda ResourcesLtd can comfortably handle its current debt levels. 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. To that end, you should be aware of the 1 warning sign we've spotted with Shengda ResourcesLtd .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.