Does China Coal Xinji EnergyLtd (SHSE:601918) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 China Coal Xinji Energy Co.,Ltd (SHSE:601918) makes use of debt. But the real question is whether this debt is making the company risky.

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Coal Xinji EnergyLtd

How Much Debt Does China Coal Xinji EnergyLtd Carry?

The image below, which you can click on for greater detail, shows that at March 2024 China Coal Xinji EnergyLtd had debt of CN¥15.9b, up from CN¥14.1b in one year. However, because it has a cash reserve of CN¥2.45b, its net debt is less, at about CN¥13.5b.

A Look At China Coal Xinji EnergyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that China Coal Xinji EnergyLtd had liabilities of CN¥8.86b due within 12 months and liabilities of CN¥13.9b due beyond that. Offsetting this, it had CN¥2.45b in cash and CN¥949.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥19.3b.

This is a mountain of leverage relative to its market capitalization of CN¥24.8b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

China Coal Xinji EnergyLtd has net debt to EBITDA of 2.7 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.0 times its interest expense, and its net debt to EBITDA, was quite high, at 2.7. China Coal Xinji EnergyLtd grew its EBIT by 3.7% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Coal Xinji EnergyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, China Coal Xinji EnergyLtd's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

China Coal Xinji EnergyLtd's level of total liabilities and net debt to EBITDA definitely weigh on it, in our esteem. But it seems to be able to cover its interest expense with its EBIT without much trouble. Taking the abovementioned factors together we do think China Coal Xinji EnergyLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For instance, we've identified 2 warning signs for China Coal Xinji EnergyLtd that 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.

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