Warren Buffett famously said, '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. We note that Kailuan Energy Chemical Co.,Ltd. (SHSE:600997) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Kailuan Energy ChemicalLtd's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2023 Kailuan Energy ChemicalLtd had debt of CN¥5.70b, up from CN¥4.63b in one year. However, its balance sheet shows it holds CN¥6.74b in cash, so it actually has CN¥1.03b net cash.
A Look At Kailuan Energy ChemicalLtd's Liabilities
The latest balance sheet data shows that Kailuan Energy ChemicalLtd had liabilities of CN¥9.60b due within a year, and liabilities of CN¥3.63b falling due after that. Offsetting this, it had CN¥6.74b in cash and CN¥4.39b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.11b.
Given Kailuan Energy ChemicalLtd has a market capitalization of CN¥13.5b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Kailuan Energy ChemicalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Kailuan Energy ChemicalLtd if management cannot prevent a repeat of the 44% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kailuan Energy ChemicalLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Kailuan Energy ChemicalLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Kailuan Energy ChemicalLtd generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing Up
Although Kailuan Energy ChemicalLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.03b. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in -CN¥462m. So we are not troubled with Kailuan Energy ChemicalLtd's debt use. 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 Kailuan Energy ChemicalLtd , 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.
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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.
