Is Shanxi Coking Coal Energy Group (SZSE:000983) A Risky Investment?

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 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 Shanxi Coking Coal Energy Group Co., Ltd. (SZSE:000983) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shanxi Coking Coal Energy Group

How Much Debt Does Shanxi Coking Coal Energy Group Carry?

You can click the graphic below for the historical numbers, but it shows that Shanxi Coking Coal Energy Group had CN¥11.5b of debt in September 2023, down from CN¥12.4b, one year before. But on the other hand it also has CN¥18.0b in cash, leading to a CN¥6.57b net cash position.

How Strong Is Shanxi Coking Coal Energy Group's Balance Sheet?

We can see from the most recent balance sheet that Shanxi Coking Coal Energy Group had liabilities of CN¥25.2b falling due within a year, and liabilities of CN¥21.7b due beyond that. Offsetting these obligations, it had cash of CN¥18.0b as well as receivables valued at CN¥5.78b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥23.1b.

Shanxi Coking Coal Energy Group has a market capitalization of CN¥65.7b, so it could very likely raise cash to ameliorate 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, Shanxi Coking Coal Energy Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shanxi Coking Coal Energy Group's load is not too heavy, because its EBIT was down 39% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanxi Coking Coal Energy Group'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Shanxi Coking Coal Energy Group 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 Coking Coal Energy Group recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While Shanxi Coking Coal Energy Group does have more liabilities than liquid assets, it also has net cash of CN¥6.57b. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in CN¥12b. So we don't have any problem with Shanxi Coking Coal Energy Group's use of debt. 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 Shanxi Coking Coal Energy Group that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.