Warren Buffett famously said, '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 can see that Ningxia Jiaze Renewables Corporation Limited (SHSE:601619) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Ningxia Jiaze Renewables's Net Debt?

As you can see below, at the end of June 2024, Ningxia Jiaze Renewables had CN¥5.66b of debt, up from CN¥4.06b a year ago. Click the image for more detail. However, it does have CN¥718.0m in cash offsetting this, leading to net debt of about CN¥4.94b.

How Healthy Is Ningxia Jiaze Renewables' Balance Sheet?

The latest balance sheet data shows that Ningxia Jiaze Renewables had liabilities of CN¥2.13b due within a year, and liabilities of CN¥12.9b falling due after that. Offsetting these obligations, it had cash of CN¥718.0m as well as receivables valued at CN¥3.71b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥10.6b.

This deficit casts a shadow over the CN¥6.77b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ningxia Jiaze Renewables would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Ningxia Jiaze Renewables has net debt to EBITDA of 2.6 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 8.2 suggests it can easily service that debt. Unfortunately, Ningxia Jiaze Renewables saw its EBIT slide 5.8% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. There's no doubt that we learn most about debt from the balance sheet. But it is Ningxia Jiaze Renewables's earnings that will influence how the balance sheet holds up in the future. 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 we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Ningxia Jiaze Renewables recorded free cash flow of 23% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Ningxia Jiaze Renewables's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Ningxia Jiaze Renewables's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Ningxia Jiaze Renewables that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.