Does Kailuan Energy ChemicalLtd (SHSE:600997) 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 Kailuan Energy Chemical Co.,Ltd. (SHSE:600997) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Kailuan Energy ChemicalLtd

What Is Kailuan Energy ChemicalLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Kailuan Energy ChemicalLtd had debt of CN¥7.13b, up from CN¥5.33b in one year. But it also has CN¥8.69b in cash to offset that, meaning it has CN¥1.57b net cash.

How Healthy Is Kailuan Energy ChemicalLtd's Balance Sheet?

We can see from the most recent balance sheet that Kailuan Energy ChemicalLtd had liabilities of CN¥10.4b falling due within a year, and liabilities of CN¥3.82b due beyond that. On the other hand, it had cash of CN¥8.69b and CN¥3.71b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.79b.

Given Kailuan Energy ChemicalLtd has a market capitalization of CN¥12.2b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Kailuan Energy ChemicalLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Kailuan Energy ChemicalLtd if management cannot prevent a repeat of the 59% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kailuan Energy ChemicalLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Kailuan Energy ChemicalLtd 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. Happily for any shareholders, Kailuan Energy ChemicalLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Kailuan Energy ChemicalLtd does have more liabilities than liquid assets, it also has net cash of CN¥1.57b. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in CN¥541m. So we are not troubled with Kailuan Energy ChemicalLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Kailuan Energy ChemicalLtd (of which 1 is potentially serious!) you should know about.

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.