Here's Why Shanxi Lu'an Environmental Energy Development (SHSE:601699) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Shanxi Lu'an Environmental Energy Development Co., Ltd. (SHSE:601699) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shanxi Lu'an Environmental Energy Development

What Is Shanxi Lu'an Environmental Energy Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shanxi Lu'an Environmental Energy Development had CN¥1.07b of debt in March 2024, down from CN¥4.20b, one year before. However, it does have CN¥24.8b in cash offsetting this, leading to net cash of CN¥23.8b.

How Healthy Is Shanxi Lu'an Environmental Energy Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanxi Lu'an Environmental Energy Development had liabilities of CN¥24.6b due within 12 months and liabilities of CN¥7.81b due beyond that. Offsetting this, it had CN¥24.8b in cash and CN¥12.1b in receivables that were due within 12 months. So it can boast CN¥4.51b more liquid assets than total liabilities.

This surplus suggests that Shanxi Lu'an Environmental Energy Development has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanxi Lu'an Environmental Energy Development boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shanxi Lu'an Environmental Energy Development's load is not too heavy, because its EBIT was down 61% 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 ultimately the future profitability of the business will decide if Shanxi Lu'an Environmental Energy Development 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanxi Lu'an Environmental Energy Development 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, Shanxi Lu'an Environmental Energy Development generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanxi Lu'an Environmental Energy Development has net cash of CN¥23.8b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥6.5b, being 96% of its EBIT. So we don't have any problem with Shanxi Lu'an Environmental Energy Development's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shanxi Lu'an Environmental Energy Development you should know about.

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.