These 4 Measures Indicate That Jiangxi Black Cat Carbon BlackLtd (SZSE:002068) Is Using Debt Extensively

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. As with many other companies Jiangxi Black Cat Carbon Black Inc.,Ltd (SZSE:002068) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Jiangxi Black Cat Carbon BlackLtd

What Is Jiangxi Black Cat Carbon BlackLtd's Debt?

As you can see below, at the end of September 2024, Jiangxi Black Cat Carbon BlackLtd had CN¥2.94b of debt, up from CN¥2.62b a year ago. Click the image for more detail. However, it also had CN¥434.2m in cash, and so its net debt is CN¥2.51b.

A Look At Jiangxi Black Cat Carbon BlackLtd's Liabilities

According to the last reported balance sheet, Jiangxi Black Cat Carbon BlackLtd had liabilities of CN¥3.55b due within 12 months, and liabilities of CN¥1.54b due beyond 12 months. Offsetting these obligations, it had cash of CN¥434.2m as well as receivables valued at CN¥2.31b due within 12 months. So its liabilities total CN¥2.34b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Jiangxi Black Cat Carbon BlackLtd has a market capitalization of CN¥6.24b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jiangxi Black Cat Carbon BlackLtd shareholders face the double whammy of a high net debt to EBITDA ratio (6.5), and fairly weak interest coverage, since EBIT is just 0.41 times the interest expense. The debt burden here is substantial. One redeeming factor for Jiangxi Black Cat Carbon BlackLtd is that it turned last year's EBIT loss into a gain of CN¥38m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jiangxi Black Cat Carbon BlackLtd'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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Jiangxi Black Cat Carbon BlackLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Jiangxi Black Cat Carbon BlackLtd's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Jiangxi Black Cat Carbon BlackLtd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Jiangxi Black Cat Carbon BlackLtd you should know about.

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.