Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Fujian Mindong Electric Power Limited Company (SZSE:000993) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Fujian Mindong Electric Power Limited's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Fujian Mindong Electric Power Limited had CN¥383.2m of debt, an increase on CN¥366.0m, over one year. However, it also had CN¥253.2m in cash, and so its net debt is CN¥130.0m.

How Strong Is Fujian Mindong Electric Power Limited's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fujian Mindong Electric Power Limited had liabilities of CN¥300.1m due within 12 months and liabilities of CN¥621.3m due beyond that. Offsetting these obligations, it had cash of CN¥253.2m as well as receivables valued at CN¥244.4m due within 12 months. So it has liabilities totalling CN¥423.8m more than its cash and near-term receivables, combined.

Of course, Fujian Mindong Electric Power Limited has a market capitalization of CN¥4.53b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Fujian Mindong Electric Power Limited's net debt is only 0.31 times its EBITDA. And its EBIT easily covers its interest expense, being 87.1 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Fujian Mindong Electric Power Limited grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fujian Mindong Electric Power Limited 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Fujian Mindong Electric Power Limited actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Fujian Mindong Electric Power Limited's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! We think Fujian Mindong Electric Power Limited is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. There's no doubt that we learn most about debt from the balance sheet. 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 2 warning signs for Fujian Mindong Electric Power Limited you should know about.

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.