Here's Why Gansu Energy Chemical (SZSE:000552) Has A Meaningful Debt Burden

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Gansu Energy Chemical Co., Ltd. (SZSE:000552) does carry debt. But is this debt a concern to shareholders?

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Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

How Much Debt Does Gansu Energy Chemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Gansu Energy Chemical had CN¥6.56b of debt, an increase on CN¥5.57b, over one year. However, it does have CN¥6.61b in cash offsetting this, leading to net cash of CN¥54.3m.

A Look At Gansu Energy Chemical's Liabilities

According to the last reported balance sheet, Gansu Energy Chemical had liabilities of CN¥5.74b due within 12 months, and liabilities of CN¥8.80b due beyond 12 months. On the other hand, it had cash of CN¥6.61b and CN¥1.20b worth of receivables due within a year. So it has liabilities totalling CN¥6.74b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Gansu Energy Chemical is worth CN¥13.6b, 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. Despite its noteworthy liabilities, Gansu Energy Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Check out our latest analysis for Gansu Energy Chemical

It is just as well that Gansu Energy Chemical's load is not too heavy, because its EBIT was down 46% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gansu Energy Chemical 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. In the last three years, Gansu Energy Chemical created free cash flow amounting to 2.9% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While Gansu Energy Chemical does have more liabilities than liquid assets, it also has net cash of CN¥54.3m. So although we see some areas for improvement, we're not too worried about Gansu Energy Chemical's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Gansu Energy Chemical (at least 1 which is significant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.