Shanxi Lu'an Environmental Energy Development (SHSE:601699) Has A Pretty Healthy Balance Sheet

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. We can see that Shanxi Lu'an Environmental Energy Development Co., Ltd. (SHSE:601699) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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

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

The image below, which you can click on for greater detail, shows that Shanxi Lu'an Environmental Energy Development had debt of CN¥810.9m at the end of June 2024, a reduction from CN¥2.25b over a year. But on the other hand it also has CN¥23.4b in cash, leading to a CN¥22.5b net cash position.

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

According to the last reported balance sheet, Shanxi Lu'an Environmental Energy Development had liabilities of CN¥25.7b due within 12 months, and liabilities of CN¥7.39b due beyond 12 months. Offsetting this, it had CN¥23.4b in cash and CN¥11.8b in receivables that were due within 12 months. So it can boast CN¥2.08b more liquid assets than total liabilities.

This short term liquidity is a sign that Shanxi Lu'an Environmental Energy Development could probably pay off its debt with ease, as its balance sheet is far from stretched. 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!

In fact Shanxi Lu'an Environmental Energy Development's saving grace is its low debt levels, because its EBIT has tanked 61% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanxi Lu'an Environmental Energy Development's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shanxi Lu'an Environmental Energy Development may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shanxi Lu'an Environmental Energy Development actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

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¥22.5b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥8.0b, being 105% of its EBIT. So we are not troubled with Shanxi Lu'an Environmental Energy Development's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shanxi Lu'an Environmental Energy Development is showing 2 warning signs in our investment analysis , you should know about...

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.