Does LIAONING ENERGY INDUSTRYLTD (SHSE:600758) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies LIAONING ENERGY INDUSTRY Co.,LTD (SHSE:600758) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for LIAONING ENERGY INDUSTRYLTD

What Is LIAONING ENERGY INDUSTRYLTD's Net Debt?

As you can see below, LIAONING ENERGY INDUSTRYLTD had CN¥3.91b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥2.41b in cash, and so its net debt is CN¥1.50b.

A Look At LIAONING ENERGY INDUSTRYLTD's Liabilities

According to the last reported balance sheet, LIAONING ENERGY INDUSTRYLTD had liabilities of CN¥6.55b due within 12 months, and liabilities of CN¥1.30b due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.41b as well as receivables valued at CN¥1.51b due within 12 months. So it has liabilities totalling CN¥3.93b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥4.77b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

LIAONING ENERGY INDUSTRYLTD has a very low debt to EBITDA ratio of 1.5 so it is strange to see weak interest coverage, with last year's EBIT being only 2.0 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, LIAONING ENERGY INDUSTRYLTD's EBIT fell a jaw-dropping 34% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since LIAONING ENERGY INDUSTRYLTD will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, LIAONING ENERGY INDUSTRYLTD actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On the face of it, LIAONING ENERGY INDUSTRYLTD's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making LIAONING ENERGY INDUSTRYLTD stock 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. 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. Be aware that LIAONING ENERGY INDUSTRYLTD is showing 3 warning signs in our investment analysis , 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.