David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Inner Mongolia Junzheng Energy & Chemical Group Co.,Ltd. (SHSE:601216) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

What Is Inner Mongolia Junzheng Energy & Chemical GroupLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Inner Mongolia Junzheng Energy & Chemical GroupLtd had CN¥6.03b of debt, an increase on CN¥2.82b, over one year. However, it also had CN¥4.02b in cash, and so its net debt is CN¥2.00b.

How Healthy Is Inner Mongolia Junzheng Energy & Chemical GroupLtd's Balance Sheet?

The latest balance sheet data shows that Inner Mongolia Junzheng Energy & Chemical GroupLtd had liabilities of CN¥9.88b due within a year, and liabilities of CN¥5.31b falling due after that. Offsetting these obligations, it had cash of CN¥4.02b as well as receivables valued at CN¥1.87b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.29b.

This deficit isn't so bad because Inner Mongolia Junzheng Energy & Chemical GroupLtd is worth CN¥32.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Inner Mongolia Junzheng Energy & Chemical GroupLtd has a low debt to EBITDA ratio of only 0.48. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. On the other hand, Inner Mongolia Junzheng Energy & Chemical GroupLtd's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Inner Mongolia Junzheng Energy & Chemical GroupLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. During the last three years, Inner Mongolia Junzheng Energy & Chemical GroupLtd produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Inner Mongolia Junzheng Energy & Chemical GroupLtd's interest cover was a real positive on this analysis, as was its net debt to EBITDA. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Inner Mongolia Junzheng Energy & Chemical GroupLtd's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Inner Mongolia Junzheng Energy & Chemical GroupLtd you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.