Here's Why Western MiningLtd (SHSE:601168) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Western Mining Co.,Ltd. (SHSE:601168) does use debt in its business. But the real question is whether this debt is making the company risky.

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When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

What Is Western MiningLtd's Debt?

As you can see below, Western MiningLtd had CN¥21.5b of debt at September 2024, down from CN¥22.4b a year prior. However, it also had CN¥7.01b in cash, and so its net debt is CN¥14.5b.

How Strong Is Western MiningLtd's Balance Sheet?

We can see from the most recent balance sheet that Western MiningLtd had liabilities of CN¥14.6b falling due within a year, and liabilities of CN¥18.0b due beyond that. Offsetting this, it had CN¥7.01b in cash and CN¥3.16b in receivables that were due within 12 months. So it has liabilities totalling CN¥22.4b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Western MiningLtd is worth CN¥43.1b, 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.

Check out our latest analysis for Western MiningLtd

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.

Western MiningLtd's net debt is only 1.5 times its EBITDA. And its EBIT covers its interest expense a whopping 16.6 times over. So we're pretty relaxed about its super-conservative use of debt. Also positive, Western MiningLtd grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Western MiningLtd'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Western MiningLtd generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Western MiningLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at the bigger picture, we think Western MiningLtd's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Western MiningLtd is showing 2 warning signs in our investment analysis , 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.