We Think Shandong Gold Mining (SHSE:600547) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Shandong Gold Mining Co., Ltd. (SHSE:600547) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. 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. 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 Gold Mining

How Much Debt Does Shandong Gold Mining Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shandong Gold Mining had CN¥64.8b of debt, an increase on CN¥51.0b, over one year. However, it also had CN¥15.5b in cash, and so its net debt is CN¥49.4b.

A Look At Shandong Gold Mining's Liabilities

Zooming in on the latest balance sheet data, we can see that Shandong Gold Mining had liabilities of CN¥61.0b due within 12 months and liabilities of CN¥41.8b due beyond that. On the other hand, it had cash of CN¥15.5b and CN¥4.62b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥82.7b.

This deficit is considerable relative to its very significant market capitalization of CN¥97.5b, so it does suggest shareholders should keep an eye on Shandong Gold Mining's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Shandong Gold Mining's debt is 3.7 times its EBITDA, and its EBIT cover its interest expense 5.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Shandong Gold Mining grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shandong Gold Mining's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Shandong Gold Mining burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Shandong Gold Mining's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Shandong Gold Mining's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 Shandong Gold Mining has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.