Stock Analysis

Here's Why Shanghai Datun Energy Resources (SHSE:600508) Can Manage Its Debt Responsibly

SHSE:600508
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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.' 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 note that Shanghai Datun Energy Resources Co., Ltd. (SHSE:600508) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Shanghai Datun Energy Resources

How Much Debt Does Shanghai Datun Energy Resources Carry?

As you can see below, at the end of March 2024, Shanghai Datun Energy Resources had CN¥1.40b of debt, up from CN¥1.11b a year ago. Click the image for more detail. But on the other hand it also has CN¥3.01b in cash, leading to a CN¥1.61b net cash position.

debt-equity-history-analysis
SHSE:600508 Debt to Equity History July 16th 2024

A Look At Shanghai Datun Energy Resources' Liabilities

The latest balance sheet data shows that Shanghai Datun Energy Resources had liabilities of CN¥3.13b due within a year, and liabilities of CN¥3.75b falling due after that. Offsetting these obligations, it had cash of CN¥3.01b as well as receivables valued at CN¥668.3m due within 12 months. So it has liabilities totalling CN¥3.20b more than its cash and near-term receivables, combined.

Shanghai Datun Energy Resources has a market capitalization of CN¥9.35b, so it could very likely raise cash to ameliorate 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. Despite its noteworthy liabilities, Shanghai Datun Energy Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Shanghai Datun Energy Resources if management cannot prevent a repeat of the 78% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Datun Energy Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Datun Energy Resources 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, Shanghai Datun Energy Resources produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Shanghai Datun Energy Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.61b. So we don't have any problem with Shanghai Datun Energy Resources's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Shanghai Datun Energy Resources that you should be aware of before investing here.

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.