Health Check: How Prudently Does Shanxi Coking (SHSE:600740) Use 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.' 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. As with many other companies Shanxi Coking Co., Ltd. (SHSE:600740) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shanxi Coking

What Is Shanxi Coking's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Shanxi Coking had debt of CN¥8.28b, up from CN¥6.84b in one year. However, it also had CN¥909.2m in cash, and so its net debt is CN¥7.37b.

How Strong Is Shanxi Coking's Balance Sheet?

According to the last reported balance sheet, Shanxi Coking had liabilities of CN¥6.85b due within 12 months, and liabilities of CN¥3.60b due beyond 12 months. Offsetting this, it had CN¥909.2m in cash and CN¥232.8m in receivables that were due within 12 months. So its liabilities total CN¥9.31b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥9.61b, so it does suggest shareholders should keep an eye on Shanxi Coking's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanxi Coking'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.

Over 12 months, Shanxi Coking made a loss at the EBIT level, and saw its revenue drop to CN¥8.2b, which is a fall of 17%. We would much prefer see growth.

Caveat Emptor

While Shanxi Coking's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥1.8b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥3.1b in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Shanxi Coking (1 makes us a bit uncomfortable) you should be aware of.

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.