Here’s why Shanghai Industrial Holdings (HKG: 363) has a heavy debt burden
Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We can see that Shanghai Industrial Holdings Limited (HKG: 363) uses debt in his business. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest analysis for Shanghai Industrial Holdings
What is the debt of Shanghai Industrial Holdings?
As you can see below, at the end of June 2021, Shanghai Industrial Holdings was in debt of HK $ 63.2 billion, up from HK $ 53.8 billion a year ago. Click on the image for more details. However, he also had HK $ 32.5 billion in cash, so his net debt is HK $ 30.7 billion.
How healthy is Shanghai Industrial Holdings’ balance sheet?
We can see from the most recent balance sheet that Shanghai Industrial Holdings had HK $ 66.7 billion in liabilities due within one year and HK $ 58.9 billion in liabilities due beyond. In compensation for these obligations, it had cash of HK $ 32.5 billion as well as receivables valued at HK $ 13.1 billion due within 12 months. Its liabilities are therefore HK $ 80.0 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the HK $ 12.7 billion company like a towering colossus of mere mortals. So we would be watching its record closely, without a doubt. After all, Shanghai Industrial Holdings would likely need a major recapitalization if it were to pay its creditors today.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Shanghai Industrial Holdings’ debt is 3.2 times its EBITDA, and its EBIT covers its interest expense 6.5 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Shanghai Industrial Holdings increased its EBIT by 2.9% last year. It’s far from incredible, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Shanghai Industrial Holdings’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to repay its debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Shanghai Industrial Holdings’ free cash flow has been 43% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
We would go so far as to say that the level of total liabilities of Shanghai Industrial Holdings was disappointing. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Overall, it seems clear to us that Shanghai Industrial Holdings’ use of debt creates risks for the company. If all goes well, it may pay off, but the downside to this debt is a greater risk of permanent losses. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 2 warning signs for Shanghai Industrial Holdings you need to be aware of it, and one of them is important.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page. free list of growing companies that have net cash on the balance sheet.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.