Is the Shanghai Electric Group (HKG:2727) using too much debt?

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Warren Buffett said: “Volatility is far from synonymous with risk. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Shanghai Electric Group Company Limited (HKG:2727) has a debt on its balance sheet. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

Discover our latest analysis for Shanghai Electric Group

What is Shanghai Electric Group’s debt?

You can click on the graph below for historical figures, but it shows that in March 2022, Shanghai Electric Group had a debt of 46.4 billion Canadian yen, an increase from 44.2 billion Canadian yen , over one year. But he also has 51.6 billion yen in cash to offset that, meaning he has a net cash of 5.17 billion yen.

SEHK: 2727 Historical Debt to Equity July 25, 2022

A look at the liabilities of Shanghai Electric Group

We can see from the most recent balance sheet that Shanghai Electric Group had liabilities of 161.5 billion yen coming due within one year, and liabilities of 33.7 billion yen due beyond. On the other hand, it had a cash position of 51.6 billion Canadian yen and 87.6 billion national yen of receivables due within the year. It therefore has liabilities totaling 56.0 billion Canadian yen more than its cash and short-term receivables, combined.

This deficit is considerable compared to its market capitalization of 61.2 billion Canadian yen, so it suggests that shareholders monitor the use of debt by Shanghai Electric Group. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution. Despite its large liabilities, Shanghai Electric Group has a net cash position, so it is fair to say that it is not very leveraged! The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Shanghai Electric Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Over 12 months, Shanghai Electric Group recorded a loss in EBIT and saw its revenue fall to 131 billion Canadian yen, a decrease of 12%. This is not what we hope to see.

So how risky is Shanghai Electric Group?

By their very nature, companies that lose money are riskier than those with a long history of profitability. And the fact is that over the past twelve months, Shanghai Electric Group has been losing money in earnings before interest and taxes (EBIT). And during the same period, it recorded a negative free cash outflow of 10 billion yen and recorded a book loss of 11 billion yen. With just 5.17 billion Canadian yen on the balance sheet, it looks like it will soon have to raise capital again. In summary, we are a little skeptical of this one, as it looks quite risky in the absence of free cash flow. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Shanghai Electric Group you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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