Is Jinjian Cereals IndustryLtd (SHSE:600127) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Jinjian Cereals Industry Co.,Ltd. (SHSE:600127) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Jinjian Cereals IndustryLtd

What Is Jinjian Cereals IndustryLtd's Debt?

The image below, which you can click on for greater detail, shows that Jinjian Cereals IndustryLtd had debt of CN¥629.2m at the end of September 2023, a reduction from CN¥708.1m over a year. On the flip side, it has CN¥199.0m in cash leading to net debt of about CN¥430.2m.

How Healthy Is Jinjian Cereals IndustryLtd's Balance Sheet?

We can see from the most recent balance sheet that Jinjian Cereals IndustryLtd had liabilities of CN¥873.6m falling due within a year, and liabilities of CN¥115.1m due beyond that. On the other hand, it had cash of CN¥199.0m and CN¥79.5m worth of receivables due within a year. So it has liabilities totalling CN¥710.2m more than its cash and near-term receivables, combined.

Of course, Jinjian Cereals IndustryLtd has a market capitalization of CN¥4.43b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jinjian Cereals IndustryLtd shareholders face the double whammy of a high net debt to EBITDA ratio (9.1), and fairly weak interest coverage, since EBIT is just 0.60 times the interest expense. The debt burden here is substantial. One redeeming factor for Jinjian Cereals IndustryLtd is that it turned last year's EBIT loss into a gain of CN¥15m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jinjian Cereals IndustryLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Jinjian Cereals IndustryLtd actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Jinjian Cereals IndustryLtd's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Jinjian Cereals IndustryLtd's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For example Jinjian Cereals IndustryLtd has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.