Is Ningxia Baofeng Energy Group (SHSE:600989) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Ningxia Baofeng Energy Group Co., Ltd. (SHSE:600989) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Ningxia Baofeng Energy Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Ningxia Baofeng Energy Group had CN¥28.4b of debt, an increase on CN¥20.8b, over one year. However, it also had CN¥2.48b in cash, and so its net debt is CN¥26.0b.

How Healthy Is Ningxia Baofeng Energy Group's Balance Sheet?

The latest balance sheet data shows that Ningxia Baofeng Energy Group had liabilities of CN¥21.3b due within a year, and liabilities of CN¥25.3b falling due after that. Offsetting these obligations, it had cash of CN¥2.48b as well as receivables valued at CN¥394.8m due within 12 months. So its liabilities total CN¥43.7b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Ningxia Baofeng Energy Group has a huge market capitalization of CN¥130.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

See our latest analysis for Ningxia Baofeng Energy Group

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that Ningxia Baofeng Energy Group's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its commanding EBIT of 12.7 times its interest expense, implies the debt load is as light as a peacock feather. We note that Ningxia Baofeng Energy Group grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Ningxia Baofeng Energy Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Ningxia Baofeng Energy Group 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

Based on what we've seen Ningxia Baofeng Energy Group is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Ningxia Baofeng Energy Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. We've identified 2 warning signs with Ningxia Baofeng Energy Group , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.