Does Jiangsu New Energy Development (SHSE:603693) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Jiangsu New Energy Development Co., Ltd. (SHSE:603693) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Jiangsu New Energy Development

What Is Jiangsu New Energy Development's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Jiangsu New Energy Development had debt of CN¥7.85b, up from CN¥5.34b in one year. However, it also had CN¥1.74b in cash, and so its net debt is CN¥6.11b.

How Strong Is Jiangsu New Energy Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu New Energy Development had liabilities of CN¥1.83b due within 12 months and liabilities of CN¥7.55b due beyond that. Offsetting these obligations, it had cash of CN¥1.74b as well as receivables valued at CN¥3.64b due within 12 months. So it has liabilities totalling CN¥4.00b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Jiangsu New Energy Development has a market capitalization of CN¥9.05b, 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jiangsu New Energy Development's debt is 4.1 times its EBITDA, and its EBIT cover its interest expense 3.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Jiangsu New Energy Development improved its EBIT by 5.3% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiangsu New Energy Development's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Looking at the most recent three years, Jiangsu New Energy Development recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Jiangsu New Energy Development's net debt to EBITDA and its interest cover were discouraging. But its not so bad at growing its EBIT. When we consider all the factors discussed, it seems to us that Jiangsu New Energy Development is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 2 warning signs for Jiangsu New Energy Development you should be aware of, and 1 of them is concerning.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.