Here's Why Liaoning Dingjide Petrochemical (SHSE:603255) Has A Meaningful Debt Burden

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Liaoning Dingjide Petrochemical Co., Ltd. (SHSE:603255) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Liaoning Dingjide Petrochemical

How Much Debt Does Liaoning Dingjide Petrochemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Liaoning Dingjide Petrochemical had CN¥422.3m of debt, an increase on CN¥137.9m, over one year. However, it does have CN¥410.4m in cash offsetting this, leading to net debt of about CN¥11.9m.

How Strong Is Liaoning Dingjide Petrochemical's Balance Sheet?

We can see from the most recent balance sheet that Liaoning Dingjide Petrochemical had liabilities of CN¥639.5m falling due within a year, and liabilities of CN¥31.1m due beyond that. Offsetting these obligations, it had cash of CN¥410.4m as well as receivables valued at CN¥358.0m due within 12 months. So it can boast CN¥97.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Liaoning Dingjide Petrochemical could probably pay off its debt with ease, as its balance sheet is far from stretched. But either way, Liaoning Dingjide Petrochemical has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Liaoning Dingjide Petrochemical's net debt is only 0.11 times its EBITDA. And its EBIT easily covers its interest expense, being 6k times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Liaoning Dingjide Petrochemical if management cannot prevent a repeat of the 47% 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 you can't view debt in total isolation; since Liaoning Dingjide Petrochemical will need earnings to service that debt. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Liaoning Dingjide Petrochemical burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Liaoning Dingjide Petrochemical's EBIT growth rate has us nervous. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. We think that Liaoning Dingjide Petrochemical's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Liaoning Dingjide Petrochemical (including 2 which are a bit unpleasant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.