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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shaanxi Heimao Coking Co., Ltd. (SHSE:601015) does use debt in its business. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Shaanxi Heimao Coking Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shaanxi Heimao Coking had CN¥4.61b of debt, an increase on CN¥4.42b, over one year. However, it also had CN¥1.24b in cash, and so its net debt is CN¥3.37b.
How Healthy Is Shaanxi Heimao Coking's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shaanxi Heimao Coking had liabilities of CN¥8.96b due within 12 months and liabilities of CN¥2.71b due beyond that. On the other hand, it had cash of CN¥1.24b and CN¥251.4m worth of receivables due within a year. So it has liabilities totalling CN¥10.2b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's CN¥7.33b market capitalization, you might well be inclined to review the balance sheet intently. 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 it is Shaanxi Heimao Coking'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.
In the last year Shaanxi Heimao Coking had a loss before interest and tax, and actually shrunk its revenue by 16%, to CN¥16b. That's not what we would hope to see.
Caveat Emptor
Not only did Shaanxi Heimao Coking'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¥897m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CN¥597m over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Shaanxi Heimao Coking .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
