Health Check: How Prudently Does Shanxi Meijin EnergyLtd (SZSE:000723) Use Debt?

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 Shanxi Meijin Energy Co.,Ltd. (SZSE:000723) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shanxi Meijin EnergyLtd

What Is Shanxi Meijin EnergyLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shanxi Meijin EnergyLtd had debt of CN¥8.73b, up from CN¥5.84b in one year. However, because it has a cash reserve of CN¥4.68b, its net debt is less, at about CN¥4.06b.

A Look At Shanxi Meijin EnergyLtd's Liabilities

We can see from the most recent balance sheet that Shanxi Meijin EnergyLtd had liabilities of CN¥17.9b falling due within a year, and liabilities of CN¥9.50b due beyond that. On the other hand, it had cash of CN¥4.68b and CN¥2.41b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥20.4b.

This deficit is considerable relative to its market capitalization of CN¥21.4b, so it does suggest shareholders should keep an eye on Shanxi Meijin EnergyLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Shanxi Meijin EnergyLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shanxi Meijin EnergyLtd's revenue was pretty flat, and it made a negative EBIT. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, Shanxi Meijin EnergyLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥672m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥2.6b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Shanxi Meijin EnergyLtd has 1 warning sign we think you should be aware of.

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.