Here's Why Shandong Mining Machinery Group (SZSE:002526) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shandong Mining Machinery Group Co., Ltd. (SZSE:002526) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shandong Mining Machinery Group

How Much Debt Does Shandong Mining Machinery Group Carry?

The chart below, which you can click on for greater detail, shows that Shandong Mining Machinery Group had CN¥404.0m in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥1.00b in cash, so it actually has CN¥600.3m net cash.

A Look At Shandong Mining Machinery Group's Liabilities

The latest balance sheet data shows that Shandong Mining Machinery Group had liabilities of CN¥1.84b due within a year, and liabilities of CN¥4.61m falling due after that. Offsetting this, it had CN¥1.00b in cash and CN¥1.81b in receivables that were due within 12 months. So it actually has CN¥975.6m more liquid assets than total liabilities.

This excess liquidity suggests that Shandong Mining Machinery Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Shandong Mining Machinery Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Shandong Mining Machinery Group grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shandong Mining Machinery 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shandong Mining Machinery Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Shandong Mining Machinery Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shandong Mining Machinery Group has net cash of CN¥600.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 69% over the last year. So we don't think Shandong Mining Machinery Group's use of debt is risky. 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. Be aware that Shandong Mining Machinery Group is showing 2 warning signs in our investment analysis , you should know about...

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.