Xinjiang Tianfu Energy (SHSE:600509) Use Of Debt Could Be Considered Risky

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. We can see that Xinjiang Tianfu Energy Co., Ltd. (SHSE:600509) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Xinjiang Tianfu Energy

What Is Xinjiang Tianfu Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Xinjiang Tianfu Energy had CN¥11.7b of debt, an increase on CN¥11.1b, over one year. On the flip side, it has CN¥1.30b in cash leading to net debt of about CN¥10.4b.

How Healthy Is Xinjiang Tianfu Energy's Balance Sheet?

According to the last reported balance sheet, Xinjiang Tianfu Energy had liabilities of CN¥8.00b due within 12 months, and liabilities of CN¥11.0b due beyond 12 months. Offsetting this, it had CN¥1.30b in cash and CN¥4.33b in receivables that were due within 12 months. So it has liabilities totalling CN¥13.4b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥9.14b, we think shareholders really should watch Xinjiang Tianfu Energy's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 5.2 hit our confidence in Xinjiang Tianfu Energy like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Xinjiang Tianfu Energy saw its EBIT tank 39% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Xinjiang Tianfu Energy'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Xinjiang Tianfu Energy 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, Xinjiang Tianfu Energy's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its net debt to EBITDA also fails to instill confidence. We should also note that Electric Utilities industry companies like Xinjiang Tianfu Energy commonly do use debt without problems. We think the chances that Xinjiang Tianfu Energy has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. 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 Xinjiang Tianfu Energy has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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.