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. We can see that Shanxi Meijin Energy Co.,Ltd. (SZSE:000723) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Shanxi Meijin EnergyLtd's Debt?

As you can see below, at the end of June 2024, Shanxi Meijin EnergyLtd had CN¥7.68b of debt, up from CN¥4.69b a year ago. Click the image for more detail. However, it also had CN¥3.69b in cash, and so its net debt is CN¥3.99b.

How Strong Is Shanxi Meijin EnergyLtd's Balance Sheet?

The latest balance sheet data shows that Shanxi Meijin EnergyLtd had liabilities of CN¥16.9b due within a year, and liabilities of CN¥9.07b falling due after that. Offsetting these obligations, it had cash of CN¥3.69b as well as receivables valued at CN¥2.34b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥20.0b.

This is a mountain of leverage relative to its market capitalization of CN¥22.3b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanxi Meijin EnergyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Shanxi Meijin EnergyLtd made a loss at the EBIT level, and saw its revenue drop to CN¥20b, which is a fall of 5.2%. That's not what we would hope to see.

Caveat Emptor

Importantly, Shanxi Meijin EnergyLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥783m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥3.4b of cash over the last year. So in short it's a really risky stock. For riskier companies like Shanxi Meijin EnergyLtd 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.

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.

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.