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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Gansu Energy Chemical Co., Ltd. (SZSE:000552) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Gansu Energy Chemical
How Much Debt Does Gansu Energy Chemical Carry?
As you can see below, at the end of September 2023, Gansu Energy Chemical had CN„5.57b of debt, up from CN„2.29b a year ago. Click the image for more detail. However, it does have CN„7.49b in cash offsetting this, leading to net cash of CN„1.92b.
How Strong Is Gansu Energy Chemical's Balance Sheet?
The latest balance sheet data shows that Gansu Energy Chemical had liabilities of CN„6.32b due within a year, and liabilities of CN„6.97b falling due after that. On the other hand, it had cash of CN„7.49b and CN„973.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN„4.82b.
This deficit isn't so bad because Gansu Energy Chemical is worth CN„15.9b, 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. While it does have liabilities worth noting, Gansu Energy Chemical also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact Gansu Energy Chemical's saving grace is its low debt levels, because its EBIT has tanked 54% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Gansu Energy Chemical's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Gansu Energy Chemical 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 most recent three years, Gansu Energy Chemical recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
Although Gansu Energy Chemical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN„1.92b. So we are not troubled with Gansu Energy Chemical's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Gansu Energy Chemical is showing 4 warning signs in our investment analysis , and 1 of those is significant...
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.
About SZSE:000552
Adequate balance sheet average dividend payer.
