Is Inner Mongolia Junzheng Energy & Chemical GroupLtd (SHSE:601216) 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.' 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. Importantly, Inner Mongolia Junzheng Energy & Chemical Group Co.,Ltd. (SHSE:601216) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Inner Mongolia Junzheng Energy & Chemical GroupLtd

How Much Debt Does Inner Mongolia Junzheng Energy & Chemical GroupLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Inner Mongolia Junzheng Energy & Chemical GroupLtd had debt of CN¥7.19b, up from CN¥3.48b in one year. However, because it has a cash reserve of CN¥4.36b, its net debt is less, at about CN¥2.84b.

How Strong Is Inner Mongolia Junzheng Energy & Chemical GroupLtd's Balance Sheet?

According to the last reported balance sheet, Inner Mongolia Junzheng Energy & Chemical GroupLtd had liabilities of CN¥9.94b due within 12 months, and liabilities of CN¥6.18b due beyond 12 months. Offsetting this, it had CN¥4.36b in cash and CN¥1.89b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.88b.

Since publicly traded Inner Mongolia Junzheng Energy & Chemical GroupLtd shares are worth a total of CN¥52.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Inner Mongolia Junzheng Energy & Chemical GroupLtd has a low debt to EBITDA ratio of only 0.71. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. But the other side of the story is that Inner Mongolia Junzheng Energy & Chemical GroupLtd saw its EBIT decline by 7.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is Inner Mongolia Junzheng Energy & Chemical GroupLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Inner Mongolia Junzheng Energy & Chemical GroupLtd recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Inner Mongolia Junzheng Energy & Chemical GroupLtd was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to grow its EBIT. When we consider all the elements mentioned above, it seems to us that Inner Mongolia Junzheng Energy & Chemical GroupLtd is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example Inner Mongolia Junzheng Energy & Chemical GroupLtd has 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

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.