Here's Why China Sanjiang Fine Chemicals (HKG:2198) Is Weighed Down By Its Debt Load - Simply Wall St News

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. As with many other companies China Sanjiang Fine Chemicals Company Limited (HKG:2198) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 China Sanjiang Fine Chemicals

The chart below, which you can click on for greater detail, shows that China Sanjiang Fine Chemicals had CN¥11.5b in debt in June 2024; about the same as the year before. However, because it has a cash reserve of CN¥572.0m, its net debt is less, at about CN¥11.0b.

We can see from the most recent balance sheet that China Sanjiang Fine Chemicals had liabilities of CN¥13.4b falling due within a year, and liabilities of CN¥3.56b due beyond that. Offsetting these obligations, it had cash of CN¥572.0m as well as receivables valued at CN¥1.44b due within 12 months. So it has liabilities totalling CN¥15.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥2.04b 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'd watch its balance sheet closely, without a doubt. At the end of the day, China Sanjiang Fine Chemicals would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Sanjiang Fine Chemicals has a rather high debt to EBITDA ratio of 6.7 which suggests a meaningful debt load. However, its interest coverage of 3.9 is reasonably strong, which is a good sign. One redeeming factor for China Sanjiang Fine Chemicals is that it turned last year's EBIT loss into a gain of CN¥827m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Sanjiang Fine Chemicals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, China Sanjiang Fine Chemicals burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

To be frank both China Sanjiang Fine Chemicals's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like China Sanjiang Fine Chemicals has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for China Sanjiang Fine Chemicals you should be aware of, and 2 of them can't be ignored.

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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.

An investment holding company, manufactures and supplies ethylene oxide and glycol, propylene, polypropylene, methyl tert-butyl ether (MTBE), surfactants, and ethanolamine in the People’s Republic of China, Japan, and Singapore.

Low with imperfect balance sheet.