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 Henan Dayou Energy Co., Ltd (SHSE:600403) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Henan Dayou Energy's Debt?

The chart below, which you can click on for greater detail, shows that Henan Dayou Energy had CN¥5.88b in debt in March 2024; about the same as the year before. However, it does have CN¥4.20b in cash offsetting this, leading to net debt of about CN¥1.68b.

How Healthy Is Henan Dayou Energy's Balance Sheet?

According to the last reported balance sheet, Henan Dayou Energy had liabilities of CN¥11.7b due within 12 months, and liabilities of CN¥2.01b due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.20b as well as receivables valued at CN¥941.6m due within 12 months. So it has liabilities totalling CN¥8.53b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥6.05b, 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. 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 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¥5.2b, which is a fall of 37%. That makes us nervous, to say the least.

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¥899m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CN¥760m in negative free cash flow over the last year. That means it's on the risky side of things. For riskier companies like Henan Dayou Energy I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.

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