We Think Shanghai Datun Energy Resources (SHSE:600508) Is Taking Some Risk With Its Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Shanghai Datun Energy Resources Co., Ltd. (SHSE:600508) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Shanghai Datun Energy Resources

How Much Debt Does Shanghai Datun Energy Resources Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Datun Energy Resources had debt of CN¥1.39b, up from CN¥1.29b in one year. However, it does have CN¥2.72b in cash offsetting this, leading to net cash of CN¥1.33b.

A Look At Shanghai Datun Energy Resources' Liabilities

The latest balance sheet data shows that Shanghai Datun Energy Resources had liabilities of CN¥3.43b due within a year, and liabilities of CN¥3.83b falling due after that. Offsetting this, it had CN¥2.72b in cash and CN¥1.23b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.31b.

Shanghai Datun Energy Resources has a market capitalization of CN¥9.63b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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!

Shareholders should be aware that Shanghai Datun Energy Resources's EBIT was down 76% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Datun Energy Resources's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 59% 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

While Shanghai Datun Energy Resources does have more liabilities than liquid assets, it also has net cash of CN¥1.33b. So although we see some areas for improvement, we're not too worried about Shanghai Datun Energy Resources's balance sheet. 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. We've identified 2 warning signs with Shanghai Datun Energy Resources (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.