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.' 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. We note that Henan Dayou Energy Co., Ltd (SHSE:600403) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Henan Dayou Energy's Net Debt?

As you can see below, Henan Dayou Energy had CN¥5.79b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥5.29b in cash leading to net debt of about CN¥496.4m.

How Healthy Is Henan Dayou Energy's Balance Sheet?

We can see from the most recent balance sheet that Henan Dayou Energy had liabilities of CN¥12.2b falling due within a year, and liabilities of CN¥2.80b due beyond that. Offsetting these obligations, it had cash of CN¥5.29b as well as receivables valued at CN¥1.06b due within 12 months. So its liabilities total CN¥8.64b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥7.79b, we think shareholders really should watch Henan Dayou Energy's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Henan Dayou Energy will need earnings to service that debt. 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.

Over 12 months, Henan Dayou Energy made a loss at the EBIT level, and saw its revenue drop to CN¥4.9b, which is a fall of 38%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Henan Dayou Energy's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥890m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CN¥330m over the last twelve months. So suffice it to say we consider the stock to be risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Henan Dayou Energy's profit, revenue, and operating cashflow have changed over the last few years.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.