We Think Jiangsu Xukuang Energy (SHSE:600925) 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.' 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 Jiangsu Xukuang Energy Co., Ltd. (SHSE:600925) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Jiangsu Xukuang Energy

What Is Jiangsu Xukuang Energy's Net Debt?

As you can see below, at the end of September 2024, Jiangsu Xukuang Energy had CN¥7.91b of debt, up from CN¥6.79b a year ago. Click the image for more detail. However, it does have CN¥6.16b in cash offsetting this, leading to net debt of about CN¥1.75b.

How Healthy Is Jiangsu Xukuang Energy's Balance Sheet?

We can see from the most recent balance sheet that Jiangsu Xukuang Energy had liabilities of CN¥10.5b falling due within a year, and liabilities of CN¥10.7b due beyond that. Offsetting these obligations, it had cash of CN¥6.16b as well as receivables valued at CN¥3.76b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥11.3b.

This deficit isn't so bad because Jiangsu Xukuang Energy is worth CN¥37.2b, 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Jiangsu Xukuang Energy's net debt is only 0.41 times its EBITDA. And its EBIT easily covers its interest expense, being 84.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Jiangsu Xukuang Energy has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jiangsu Xukuang Energy 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Jiangsu Xukuang Energy created free cash flow amounting to 5.8% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Jiangsu Xukuang Energy's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that Jiangsu Xukuang Energy's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Jiangsu Xukuang Energy's earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.