Inner Mongolia Yitai CoalLtd (SHSE:900948) Has A Pretty 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. Importantly, Inner Mongolia Yitai Coal Co.,Ltd (SHSE:900948) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Inner Mongolia Yitai CoalLtd

How Much Debt Does Inner Mongolia Yitai CoalLtd Carry?

As you can see below, at the end of March 2024, Inner Mongolia Yitai CoalLtd had CN¥20.4b of debt, up from CN¥16.0b a year ago. Click the image for more detail. However, it does have CN¥18.3b in cash offsetting this, leading to net debt of about CN¥2.05b.

How Strong Is Inner Mongolia Yitai CoalLtd's Balance Sheet?

According to the last reported balance sheet, Inner Mongolia Yitai CoalLtd had liabilities of CN¥14.1b due within 12 months, and liabilities of CN¥17.0b due beyond 12 months. Offsetting these obligations, it had cash of CN¥18.3b as well as receivables valued at CN¥2.67b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥10.1b.

This deficit isn't so bad because Inner Mongolia Yitai CoalLtd is worth CN¥41.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). 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).

Inner Mongolia Yitai CoalLtd has a low debt to EBITDA ratio of only 0.17. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. The modesty of its debt load may become crucial for Inner Mongolia Yitai CoalLtd if management cannot prevent a repeat of the 46% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Inner Mongolia Yitai CoalLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, Inner Mongolia Yitai CoalLtd 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.

Our View

The good news is that Inner Mongolia Yitai CoalLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its EBIT growth rate has the opposite effect. All these things considered, it appears that Inner Mongolia Yitai CoalLtd can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For instance, we've identified 2 warning signs for Inner Mongolia Yitai CoalLtd (1 is concerning) you should be aware of.

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.