We Think Inner Mongolia MengDian HuaNeng Thermal Power (SHSE:600863) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Inner Mongolia MengDian HuaNeng Thermal Power Corporation Limited (SHSE:600863) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Inner Mongolia MengDian HuaNeng Thermal Power

How Much Debt Does Inner Mongolia MengDian HuaNeng Thermal Power Carry?

As you can see below, Inner Mongolia MengDian HuaNeng Thermal Power had CN¥9.60b of debt at March 2024, down from CN¥13.9b a year prior. However, because it has a cash reserve of CN¥1.56b, its net debt is less, at about CN¥8.05b.

How Strong Is Inner Mongolia MengDian HuaNeng Thermal Power's Balance Sheet?

The latest balance sheet data shows that Inner Mongolia MengDian HuaNeng Thermal Power had liabilities of CN¥5.50b due within a year, and liabilities of CN¥9.68b falling due after that. On the other hand, it had cash of CN¥1.56b and CN¥5.04b worth of receivables due within a year. So it has liabilities totalling CN¥8.58b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Inner Mongolia MengDian HuaNeng Thermal Power has a market capitalization of CN¥29.7b, 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). 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).

Inner Mongolia MengDian HuaNeng Thermal Power has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 22.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Inner Mongolia MengDian HuaNeng Thermal Power has increased its EBIT by 2.6% over twelve months, which should ease any concerns about debt repayment. 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 Inner Mongolia MengDian HuaNeng Thermal Power can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Inner Mongolia MengDian HuaNeng Thermal Power actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Inner Mongolia MengDian HuaNeng Thermal Power's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! When we consider the range of factors above, it looks like Inner Mongolia MengDian HuaNeng Thermal Power is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 - Inner Mongolia MengDian HuaNeng Thermal Power has 1 warning sign we think 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.

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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.

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