We Think China Northern Rare Earth (Group) High-TechLtd (SHSE:600111) Can Stay On Top Of Its Debt

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. Importantly, China Northern Rare Earth (Group) High-Tech Co.,Ltd (SHSE:600111) does carry debt. But is this debt a concern to shareholders?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

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

How Much Debt Does China Northern Rare Earth (Group) High-TechLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China Northern Rare Earth (Group) High-TechLtd had CN¥8.24b of debt, an increase on CN¥7.40b, over one year. However, it does have CN¥6.58b in cash offsetting this, leading to net debt of about CN¥1.66b.

How Strong 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¥9.27b due within a year, and liabilities of CN¥5.28b falling due after that. Offsetting this, it had CN¥6.58b in cash and CN¥8.45b in receivables that were due within 12 months. So it can boast CN¥472.2m more liquid assets than 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 it's very unlikely that the CN¥76.1b company is short on cash, but still worth keeping an eye on the 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

China Northern Rare Earth (Group) High-TechLtd has a low net debt to EBITDA ratio of only 0.58. And its EBIT easily covers its interest expense, being 12.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that China Northern Rare Earth (Group) High-TechLtd's load is not too heavy, because its EBIT was down 28% over the last year. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, China Northern Rare Earth (Group) High-TechLtd's free cash flow amounted to 47% 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. 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. Be aware that China Northern Rare Earth (Group) High-TechLtd is showing 1 warning sign in our investment analysis , you should know about...

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.