Is Shandong Nanshan AluminiumLtd (SHSE:600219) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shandong Nanshan Aluminium Co.,Ltd. (SHSE:600219) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shandong Nanshan AluminiumLtd

What Is Shandong Nanshan AluminiumLtd's Net Debt?

As you can see below, Shandong Nanshan AluminiumLtd had CN¥7.66b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥26.4b in cash to offset that, meaning it has CN¥18.8b net cash.

A Look At Shandong Nanshan AluminiumLtd's Liabilities

We can see from the most recent balance sheet that Shandong Nanshan AluminiumLtd had liabilities of CN¥14.1b falling due within a year, and liabilities of CN¥675.5m due beyond that. Offsetting these obligations, it had cash of CN¥26.4b as well as receivables valued at CN¥5.95b due within 12 months. So it actually has CN¥17.6b more liquid assets than total liabilities.

This surplus liquidity suggests that Shandong Nanshan AluminiumLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Shandong Nanshan AluminiumLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Shandong Nanshan AluminiumLtd's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shandong Nanshan AluminiumLtd 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. While Shandong Nanshan AluminiumLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Shandong Nanshan AluminiumLtd recorded free cash flow worth a fulsome 88% 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 we empathize with investors who find debt concerning, you should keep in mind that Shandong Nanshan AluminiumLtd has net cash of CN¥18.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in CN¥2.0b. So we don't think Shandong Nanshan AluminiumLtd's use of debt is risky. 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 - Shandong Nanshan AluminiumLtd has 2 warning signs we think 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.

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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.