Huaibei Mining HoldingsLtd (SHSE:600985) Seems To Use Debt Quite Sensibly

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.' 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 Huaibei Mining Holdings Co.,Ltd. (SHSE:600985) makes use of debt. But the more important question is: how much risk is that debt creating?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Huaibei Mining HoldingsLtd

What Is Huaibei Mining HoldingsLtd's Debt?

The image below, which you can click on for greater detail, shows that Huaibei Mining HoldingsLtd had debt of CN¥6.85b at the end of March 2024, a reduction from CN¥13.3b over a year. However, it does have CN¥8.11b in cash offsetting this, leading to net cash of CN¥1.25b.

How Strong Is Huaibei Mining HoldingsLtd's Balance Sheet?

We can see from the most recent balance sheet that Huaibei Mining HoldingsLtd had liabilities of CN¥26.4b falling due within a year, and liabilities of CN¥14.5b due beyond that. Offsetting these obligations, it had cash of CN¥8.11b as well as receivables valued at CN¥5.98b due within 12 months. So its liabilities total CN¥26.8b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Huaibei Mining HoldingsLtd is worth CN¥47.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Huaibei Mining HoldingsLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Huaibei Mining HoldingsLtd's load is not too heavy, because its EBIT was down 32% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Huaibei Mining HoldingsLtd 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 Huaibei Mining HoldingsLtd 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. During the last three years, Huaibei Mining HoldingsLtd generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

Although Huaibei Mining HoldingsLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥1.25b. And it impressed us with free cash flow of CN¥5.3b, being 86% of its EBIT. So we are not troubled with Huaibei Mining HoldingsLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Huaibei Mining HoldingsLtd is showing 2 warning signs in our investment analysis , you should know about...

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.

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