Henan Shenhuo Coal Industry and Electricity Power (SZSE:000933) Has A Pretty Healthy Balance Sheet

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, Henan Shenhuo Coal Industry and Electricity Power Co. Ltd (SZSE:000933) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Henan Shenhuo Coal Industry and Electricity Power

What Is Henan Shenhuo Coal Industry and Electricity Power's Net Debt?

The image below, which you can click on for greater detail, shows that Henan Shenhuo Coal Industry and Electricity Power had debt of CN¥22.1b at the end of March 2024, a reduction from CN¥27.2b over a year. However, because it has a cash reserve of CN¥14.4b, its net debt is less, at about CN¥7.65b.

How Healthy Is Henan Shenhuo Coal Industry and Electricity Power's Balance Sheet?

The latest balance sheet data shows that Henan Shenhuo Coal Industry and Electricity Power had liabilities of CN¥26.6b due within a year, and liabilities of CN¥7.73b falling due after that. Offsetting these obligations, it had cash of CN¥14.4b as well as receivables valued at CN¥1.27b due within 12 months. So its liabilities total CN¥18.6b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Henan Shenhuo Coal Industry and Electricity Power is worth CN¥37.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Henan Shenhuo Coal Industry and Electricity Power has a low debt to EBITDA ratio of only 0.89. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. It is just as well that Henan Shenhuo Coal Industry and Electricity Power's load is not too heavy, because its EBIT was down 35% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Henan Shenhuo Coal Industry and Electricity Power's ability to maintain a healthy balance sheet going forward. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Henan Shenhuo Coal Industry and Electricity Power actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Henan Shenhuo Coal Industry and Electricity Power's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Henan Shenhuo Coal Industry and Electricity Power's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Henan Shenhuo Coal Industry and Electricity Power 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.