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.' 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. As with many other companies China Nonferrous Metal Industry's Foreign Engineering and Construction Co.,Ltd. (SZSE:000758) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's Net Debt?

The image below, which you can click on for greater detail, shows that China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd had debt of CN¥4.80b at the end of March 2024, a reduction from CN¥6.37b over a year. However, because it has a cash reserve of CN¥3.65b, its net debt is less, at about CN¥1.14b.

A Look At China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd had liabilities of CN¥7.46b due within 12 months and liabilities of CN¥3.00b due beyond that. Offsetting this, it had CN¥3.65b in cash and CN¥3.17b in receivables that were due within 12 months. So it has liabilities totalling CN¥3.64b more than its cash and near-term receivables, combined.

This deficit isn't so bad because China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd is worth CN¥10.3b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 10.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd 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.

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. Over the last three years, China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Looking at the bigger picture, we think China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's earnings per share history for free.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com