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.' 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 Jiangsu Xukuang Energy Co., Ltd. (SHSE:600925) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 Jiangsu Xukuang Energy's Net Debt?
As you can see below, Jiangsu Xukuang Energy had CN¥6.97b of debt at March 2024, down from CN¥7.76b a year prior. However, it does have CN¥7.84b in cash offsetting this, leading to net cash of CN¥871.2m.
A Look At Jiangsu Xukuang Energy's Liabilities
According to the last reported balance sheet, Jiangsu Xukuang Energy had liabilities of CN¥9.91b due within 12 months, and liabilities of CN¥10.4b due beyond 12 months. On the other hand, it had cash of CN¥7.84b and CN¥3.24b worth of receivables due within a year. So its liabilities total CN¥9.23b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Jiangsu Xukuang Energy has a market capitalization of CN¥33.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Jiangsu Xukuang Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Jiangsu Xukuang Energy if management cannot prevent a repeat of the 33% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiangsu Xukuang Energy's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangsu Xukuang Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Jiangsu Xukuang Energy reported free cash flow worth 7.5% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing Up
While Jiangsu Xukuang Energy does have more liabilities than liquid assets, it also has net cash of CN¥871.2m. So although we see some areas for improvement, we're not too worried about Jiangsu Xukuang Energy's balance sheet. 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. For instance, we've identified 1 warning sign for Jiangsu Xukuang Energy that you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.