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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Zhejiang Shibao Company Limited (HKG:1057) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Zhejiang Shibao
What Is Zhejiang Shibao's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Zhejiang Shibao had CN¥189.1m of debt, an increase on CN¥66.1m, over one year. However, it does have CN¥283.6m in cash offsetting this, leading to net cash of CN¥94.5m.
How Healthy Is Zhejiang Shibao's Balance Sheet?
The latest balance sheet data shows that Zhejiang Shibao had liabilities of CN¥586.9m due within a year, and liabilities of CN¥59.4m falling due after that. Offsetting this, it had CN¥283.6m in cash and CN¥582.9m in receivables that were due within 12 months. So it actually has CN¥220.2m more liquid assets than total liabilities.
This surplus suggests that Zhejiang Shibao has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Zhejiang Shibao boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhejiang Shibao's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Zhejiang Shibao saw its revenue drop to CN¥992m, which is a fall of 17%. We would much prefer see growth.
So How Risky Is Zhejiang Shibao?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Zhejiang Shibao had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of CN¥167m and booked a CN¥5.3m accounting loss. With only CN¥284m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. For riskier companies like Zhejiang Shibao I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.