Shenzhen Zhongjin Lingnan Nonfemet (SZSE:000060) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd. (SZSE:000060) does use debt in its business. 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shenzhen Zhongjin Lingnan Nonfemet

How Much Debt Does Shenzhen Zhongjin Lingnan Nonfemet Carry?

As you can see below, Shenzhen Zhongjin Lingnan Nonfemet had CN¥17.2b of debt at September 2024, down from CN¥18.2b a year prior. However, because it has a cash reserve of CN¥4.80b, its net debt is less, at about CN¥12.4b.

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

The latest balance sheet data shows that Shenzhen Zhongjin Lingnan Nonfemet had liabilities of CN¥12.2b due within a year, and liabilities of CN¥15.7b falling due after that. Offsetting these obligations, it had cash of CN¥4.80b as well as receivables valued at CN¥1.24b due within 12 months. So its liabilities total CN¥21.9b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥18.3b, 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 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shenzhen Zhongjin Lingnan Nonfemet's debt is 3.6 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that Shenzhen Zhongjin Lingnan Nonfemet grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shenzhen Zhongjin Lingnan Nonfemet's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 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

We'd go so far as to say Shenzhen Zhongjin Lingnan Nonfemet's conversion of EBIT to free cash flow was disappointing. 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. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Be aware that Shenzhen Zhongjin Lingnan Nonfemet is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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.