We Think Henan Shenhuo Coal Industry and Electricity Power (SZSE:000933) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Henan Shenhuo Coal Industry and Electricity Power Co. Ltd (SZSE:000933) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 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¥18.6b at the end of September 2024, a reduction from CN¥26.8b over a year. However, it also had CN¥9.88b in cash, and so its net debt is CN¥8.69b.

How Strong 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¥25.1b due within a year, and liabilities of CN¥4.86b falling due after that. Offsetting this, it had CN¥9.88b in cash and CN¥2.18b in receivables that were due within 12 months. So its liabilities total CN¥17.9b 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¥36.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Henan Shenhuo Coal Industry and Electricity Power has a low debt to EBITDA ratio of only 1.0. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. But the bad news is that Henan Shenhuo Coal Industry and Electricity Power has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding 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 generation warms our hearts like a puppy in a bumblebee suit.

Our View

Henan Shenhuo Coal Industry and Electricity Power's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. But truth be told its EBIT growth rate had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Henan Shenhuo Coal Industry and Electricity Power is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 instance, we've identified 1 warning sign for Henan Shenhuo Coal Industry and Electricity Power that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.