Ningbo Energy GroupLtd (SHSE:600982) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Ningbo Energy Group Co.,Ltd. (SHSE:600982) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ningbo Energy GroupLtd

How Much Debt Does Ningbo Energy GroupLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Ningbo Energy GroupLtd had CN¥7.15b of debt, an increase on CN¥6.59b, over one year. However, it does have CN¥896.8m in cash offsetting this, leading to net debt of about CN¥6.26b.

How Healthy Is Ningbo Energy GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Ningbo Energy GroupLtd had liabilities of CN¥5.22b falling due within a year, and liabilities of CN¥4.32b due beyond that. On the other hand, it had cash of CN¥896.8m and CN¥2.36b worth of receivables due within a year. So it has liabilities totalling CN¥6.28b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥5.19b, we think shareholders really should watch Ningbo Energy GroupLtd'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.

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.

Strangely Ningbo Energy GroupLtd has a sky high EBITDA ratio of 11.6, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, Ningbo Energy GroupLtd grew its EBIT by 99% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ningbo Energy GroupLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ningbo Energy GroupLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Ningbo Energy GroupLtd's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. We should also note that Integrated Utilities industry companies like Ningbo Energy GroupLtd commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Ningbo Energy GroupLtd stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Ningbo Energy GroupLtd has 3 warning signs (and 1 which makes us a bit uncomfortable) 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.