These 4 Measures Indicate That Shanxi Meijin EnergyLtd (SZSE:000723) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Shanxi Meijin Energy Co.,Ltd. (SZSE:000723) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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 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 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 2023 Shanxi Meijin EnergyLtd had debt of CN¥5.84b, up from CN¥5.37b in one year. However, its balance sheet shows it holds CN¥5.89b in cash, so it actually has CN¥42.6m net cash.

How Healthy Is Shanxi Meijin EnergyLtd's Balance Sheet?

According to the last reported balance sheet, Shanxi Meijin EnergyLtd had liabilities of CN¥15.9b due within 12 months, and liabilities of CN¥7.04b due beyond 12 months. On the other hand, it had cash of CN¥5.89b and CN¥2.55b worth of receivables due within a year. So it has liabilities totalling CN¥14.5b more than its cash and near-term receivables, combined.

Shanxi Meijin EnergyLtd has a market capitalization of CN¥29.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Shanxi Meijin EnergyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Shanxi Meijin EnergyLtd's EBIT was down 54% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shanxi Meijin EnergyLtd 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. While Shanxi Meijin EnergyLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Shanxi Meijin EnergyLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While Shanxi Meijin EnergyLtd does have more liabilities than liquid assets, it also has net cash of CN¥42.6m. Despite its cash we think that Shanxi Meijin EnergyLtd seems to struggle to grow its EBIT, so we are wary of the stock. 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 2 warning signs with Shanxi Meijin EnergyLtd (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.