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.' 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. As with many other companies Shanghai Jin Jiang Capital Company Limited (HKG:2006) makes use of debt. But the real question is whether this debt is making the company risky.
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Shanghai Jin Jiang Capital
What Is Shanghai Jin Jiang Capital's Net Debt?
As you can see below, Shanghai Jin Jiang Capital had CN¥19.8b of debt at December 2018, down from CN¥23.8b a year prior. However, it also had CN¥12.8b in cash, and so its net debt is CN¥7.05b.
How Strong Is Shanghai Jin Jiang Capital's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shanghai Jin Jiang Capital had liabilities of CN¥15.7b due within 12 months and liabilities of CN¥21.5b due beyond that. Offsetting this, it had CN¥12.8b in cash and CN¥2.67b in receivables that were due within 12 months. So it has liabilities totalling CN¥21.7b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CN¥6.11b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Shanghai Jin Jiang Capital would probably need a major re-capitalization if its creditors were to demand repayment.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).