Does Tongling Nonferrous Metals GroupLtd (SZSE:000630) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Tongling Nonferrous Metals Group Co.,Ltd. (SZSE:000630) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tongling Nonferrous Metals GroupLtd

What Is Tongling Nonferrous Metals GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Tongling Nonferrous Metals GroupLtd had debt of CN¥25.9b, up from CN¥24.4b in one year. However, because it has a cash reserve of CN¥11.3b, its net debt is less, at about CN¥14.6b.

How Healthy Is Tongling Nonferrous Metals GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tongling Nonferrous Metals GroupLtd had liabilities of CN¥28.8b due within 12 months and liabilities of CN¥15.3b due beyond that. On the other hand, it had cash of CN¥11.3b and CN¥5.02b worth of receivables due within a year. So its liabilities total CN¥27.7b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥41.3b, so it does suggest shareholders should keep an eye on Tongling Nonferrous Metals GroupLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Tongling Nonferrous Metals GroupLtd's moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its strong interest cover of 11.1 times, makes us even more comfortable. But the bad news is that Tongling Nonferrous Metals GroupLtd has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Tongling Nonferrous Metals GroupLtd'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, 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, Tongling Nonferrous Metals GroupLtd produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Neither Tongling Nonferrous Metals GroupLtd's ability to grow its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that Tongling Nonferrous Metals GroupLtd is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. For example, we've discovered 2 warning signs for Tongling Nonferrous Metals GroupLtd that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.