Shandong Mining Machinery Group (SZSE:002526) Takes On Some Risk With Its Use Of Debt

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.' 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 can see that Shandong Mining Machinery Group Co., Ltd. (SZSE:002526) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shandong Mining Machinery Group

What Is Shandong Mining Machinery Group's Debt?

The image below, which you can click on for greater detail, shows that Shandong Mining Machinery Group had debt of CN¥332.6m at the end of September 2024, a reduction from CN¥404.0m over a year. But on the other hand it also has CN¥725.8m in cash, leading to a CN¥393.2m net cash position.

How Strong Is Shandong Mining Machinery Group's Balance Sheet?

The latest balance sheet data shows that Shandong Mining Machinery Group had liabilities of CN¥1.75b due within a year, and liabilities of CN¥4.78m falling due after that. Offsetting this, it had CN¥725.8m in cash and CN¥1.58b in receivables that were due within 12 months. So it can boast CN¥547.7m more liquid assets than total liabilities.

This surplus suggests that Shandong Mining Machinery Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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.

It is just as well that Shandong Mining Machinery Group's load is not too heavy, because its EBIT was down 80% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shandong Mining Machinery Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shandong Mining Machinery Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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¥393.2m, as well as more liquid assets than liabilities. So while Shandong Mining Machinery Group does not have a great balance sheet, it's certainly not too bad. 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. For instance, we've identified 4 warning signs for Shandong Mining Machinery Group (2 are a bit unpleasant) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.