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. As with many other companies Jinneng Holding Shanxi Electric Power Co.,LTD. (SZSE:000767) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Jinneng Holding Shanxi Electric PowerLTD Carry?

As you can see below, Jinneng Holding Shanxi Electric PowerLTD had CN¥36.6b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥5.88b in cash offsetting this, leading to net debt of about CN¥30.8b.

How Strong Is Jinneng Holding Shanxi Electric PowerLTD's Balance Sheet?

The latest balance sheet data shows that Jinneng Holding Shanxi Electric PowerLTD had liabilities of CN¥19.9b due within a year, and liabilities of CN¥28.3b falling due after that. On the other hand, it had cash of CN¥5.88b and CN¥9.61b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥32.8b.

This deficit casts a shadow over the CN¥8.52b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Jinneng Holding Shanxi Electric PowerLTD would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Jinneng Holding Shanxi Electric PowerLTD shareholders face the double whammy of a high net debt to EBITDA ratio (10.5), and fairly weak interest coverage, since EBIT is just 0.27 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Jinneng Holding Shanxi Electric PowerLTD's EBIT was down 52% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Jinneng Holding Shanxi Electric PowerLTD 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Jinneng Holding Shanxi Electric PowerLTD burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Jinneng Holding Shanxi Electric PowerLTD's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Jinneng Holding Shanxi Electric PowerLTD is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Jinneng Holding Shanxi Electric PowerLTD .

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.