Here's Why Pingdingshan Tianan Coal. Mining (SHSE:601666) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Pingdingshan Tianan Coal. Mining Co., Ltd. (SHSE:601666) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Pingdingshan Tianan Coal. Mining

How Much Debt Does Pingdingshan Tianan Coal. Mining Carry?

You can click the graphic below for the historical numbers, but it shows that Pingdingshan Tianan Coal. Mining had CN¥17.9b of debt in September 2024, down from CN¥18.8b, one year before. However, it does have CN¥11.4b in cash offsetting this, leading to net debt of about CN¥6.56b.

How Healthy Is Pingdingshan Tianan Coal. Mining's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pingdingshan Tianan Coal. Mining had liabilities of CN¥26.0b due within 12 months and liabilities of CN¥17.2b due beyond that. Offsetting these obligations, it had cash of CN¥11.4b as well as receivables valued at CN¥3.78b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥28.1b.

Given this deficit is actually higher than the company's market capitalization of CN¥23.3b, we think shareholders really should watch Pingdingshan Tianan Coal. Mining's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

While Pingdingshan Tianan Coal. Mining's low debt to EBITDA ratio of 0.66 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.9 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Shareholders should be aware that Pingdingshan Tianan Coal. Mining's EBIT was down 21% 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Pingdingshan Tianan Coal. Mining can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Looking at the most recent three years, Pingdingshan Tianan Coal. Mining recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Pingdingshan Tianan Coal. Mining's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Overall, it seems to us that Pingdingshan Tianan Coal. Mining's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 - Pingdingshan Tianan Coal. Mining has 3 warning signs we think you should be aware of.

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.