We Think NORINCO International Cooperation (SZSE:000065) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 NORINCO International Cooperation Ltd. (SZSE:000065) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for NORINCO International Cooperation

What Is NORINCO International Cooperation's Net Debt?

As you can see below, NORINCO International Cooperation had CN¥5.59b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥4.03b, its net debt is less, at about CN¥1.56b.

How Strong Is NORINCO International Cooperation's Balance Sheet?

We can see from the most recent balance sheet that NORINCO International Cooperation had liabilities of CN¥9.78b falling due within a year, and liabilities of CN¥4.93b due beyond that. On the other hand, it had cash of CN¥4.03b and CN¥5.65b worth of receivables due within a year. So its liabilities total CN¥5.03b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because NORINCO International Cooperation is worth CN¥12.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

NORINCO International Cooperation has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 20.0 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that NORINCO International Cooperation has seen its EBIT plunge 14% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine NORINCO International Cooperation's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, NORINCO International Cooperation recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Both NORINCO International Cooperation's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. But truth be told its EBIT growth rate had us nibbling our nails. Considering this range of data points, we think NORINCO International Cooperation is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for NORINCO International Cooperation that you should be aware of before investing here.

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.