China Northern Rare Earth (Group) High-TechLtd (SHSE:600111) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that China Northern Rare Earth (Group) High-Tech Co.,Ltd (SHSE:600111) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Northern Rare Earth (Group) High-TechLtd

What Is China Northern Rare Earth (Group) High-TechLtd's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 China Northern Rare Earth (Group) High-TechLtd had debt of CN¥8.06b, up from CN¥7.20b in one year. However, it does have CN¥6.18b in cash offsetting this, leading to net debt of about CN¥1.88b.

How Healthy Is China Northern Rare Earth (Group) High-TechLtd's Balance Sheet?

The latest balance sheet data shows that China Northern Rare Earth (Group) High-TechLtd had liabilities of CN¥9.93b due within a year, and liabilities of CN¥4.34b falling due after that. Offsetting these obligations, it had cash of CN¥6.18b as well as receivables valued at CN¥8.35b due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that China Northern Rare Earth (Group) High-TechLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥80.9b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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.

China Northern Rare Earth (Group) High-TechLtd has a low net debt to EBITDA ratio of only 0.69. And its EBIT covers its interest expense a whopping 14.5 times over. So we're pretty relaxed about its super-conservative use of debt. In fact China Northern Rare Earth (Group) High-TechLtd's saving grace is its low debt levels, because its EBIT has tanked 55% 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 ultimately the future profitability of the business will decide if China Northern Rare Earth (Group) High-TechLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, China Northern Rare Earth (Group) High-TechLtd's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

China Northern Rare Earth (Group) High-TechLtd's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the elements mentioned above, it seems to us that China Northern Rare Earth (Group) High-TechLtd is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for China Northern Rare Earth (Group) High-TechLtd that you should be aware of before investing here.

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.

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.