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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, COSCO SHIPPING Development Co., Ltd. (HKG:2866) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for COSCO SHIPPING Development

What Is COSCO SHIPPING Development's Debt?

As you can see below, COSCO SHIPPING Development had CN¥86.0b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥10.9b in cash offsetting this, leading to net debt of about CN¥75.1b.

How Strong Is COSCO SHIPPING Development's Balance Sheet?

The latest balance sheet data shows that COSCO SHIPPING Development had liabilities of CN¥29.9b due within a year, and liabilities of CN¥62.6b falling due after that. Offsetting this, it had CN¥10.9b in cash and CN¥6.23b in receivables that were due within 12 months. So it has liabilities totalling CN¥75.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥29.9b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, COSCO SHIPPING Development would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

COSCO SHIPPING Development shareholders face the double whammy of a high net debt to EBITDA ratio (11.4), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. The debt burden here is substantial. Even more troubling is the fact that COSCO SHIPPING Development actually let its EBIT decrease by 4.0% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine COSCO SHIPPING Development's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, COSCO SHIPPING Development's free cash flow amounted to 22% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both COSCO SHIPPING Development's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think COSCO SHIPPING Development has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with COSCO SHIPPING Development (at least 1 which is significant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.