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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Chengtun Mining Group Co., Ltd. (SHSE:600711) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Chengtun Mining Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Chengtun Mining Group had CN¥10.8b in debt in September 2024; about the same as the year before. However, it also had CN¥4.60b in cash, and so its net debt is CN¥6.20b.

How Healthy Is Chengtun Mining Group's Balance Sheet?

We can see from the most recent balance sheet that Chengtun Mining Group had liabilities of CN¥14.7b falling due within a year, and liabilities of CN¥5.65b due beyond that. Offsetting this, it had CN¥4.60b in cash and CN¥1.50b in receivables that were due within 12 months. So it has liabilities totalling CN¥14.2b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥15.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Chengtun Mining Group's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Better yet, Chengtun Mining Group grew its EBIT by 391% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chengtun Mining Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Chengtun Mining Group 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

Chengtun Mining Group's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Chengtun Mining Group is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 1 warning sign for Chengtun Mining Group you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.