Does Shenzhen Zhongjin Lingnan Nonfemet (SZSE:000060) Have A Healthy Balance Sheet?

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. Importantly, Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd. (SZSE:000060) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shenzhen Zhongjin Lingnan Nonfemet

What Is Shenzhen Zhongjin Lingnan Nonfemet's Net Debt?

As you can see below, at the end of March 2024, Shenzhen Zhongjin Lingnan Nonfemet had CN¥15.9b of debt, up from CN¥14.5b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥6.21b, its net debt is less, at about CN¥9.66b.

How Strong Is Shenzhen Zhongjin Lingnan Nonfemet's Balance Sheet?

The latest balance sheet data shows that Shenzhen Zhongjin Lingnan Nonfemet had liabilities of CN¥11.8b due within a year, and liabilities of CN¥16.5b falling due after that. Offsetting these obligations, it had cash of CN¥6.21b as well as receivables valued at CN¥1.15b due within 12 months. So it has liabilities totalling CN¥21.0b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥17.0b, we think shareholders really should watch Shenzhen Zhongjin Lingnan Nonfemet's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shenzhen Zhongjin Lingnan Nonfemet's debt is 3.1 times its EBITDA, and its EBIT cover its interest expense 3.9 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. However, one redeeming factor is that Shenzhen Zhongjin Lingnan Nonfemet grew its EBIT at 19% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Zhongjin Lingnan Nonfemet can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Shenzhen Zhongjin Lingnan Nonfemet saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Shenzhen Zhongjin Lingnan Nonfemet's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that Shenzhen Zhongjin Lingnan Nonfemet's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. We've identified 3 warning signs with Shenzhen Zhongjin Lingnan Nonfemet (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.