Does GuoCheng MiningLTD (SZSE:000688) 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 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. We note that GuoCheng Mining CO.,LTD (SZSE:000688) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for GuoCheng MiningLTD

How Much Debt Does GuoCheng MiningLTD Carry?

The image below, which you can click on for greater detail, shows that at September 2024 GuoCheng MiningLTD had debt of CN¥2.40b, up from CN¥2.18b in one year. However, it also had CN¥221.2m in cash, and so its net debt is CN¥2.17b.

How Strong Is GuoCheng MiningLTD's Balance Sheet?

We can see from the most recent balance sheet that GuoCheng MiningLTD had liabilities of CN¥3.20b falling due within a year, and liabilities of CN¥2.51b due beyond that. Offsetting this, it had CN¥221.2m in cash and CN¥53.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.43b.

While this might seem like a lot, it is not so bad since GuoCheng MiningLTD has a market capitalization of CN¥14.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

GuoCheng MiningLTD's net debt is 4.7 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 37.8 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. We also note that GuoCheng MiningLTD improved its EBIT from a last year's loss to a positive CN¥258m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since GuoCheng MiningLTD will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, GuoCheng MiningLTD produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis GuoCheng MiningLTD's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at managing its debt, based on its EBITDA, as wet socks are at keeping your feet warm. Considering this range of data points, we think GuoCheng MiningLTD is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. We've identified 3 warning signs with GuoCheng MiningLTD (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.