Here's Why Henan Lantian GasLtd (SHSE:605368) Can Manage Its Debt Responsibly

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. As with many other companies Henan Lantian Gas Co.,Ltd. (SHSE:605368) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Henan Lantian GasLtd

What Is Henan Lantian GasLtd's Net Debt?

As you can see below, at the end of June 2024, Henan Lantian GasLtd had CN¥1.32b of debt, up from CN¥846.7m a year ago. Click the image for more detail. However, it also had CN¥1.24b in cash, and so its net debt is CN¥79.3m.

How Strong Is Henan Lantian GasLtd's Balance Sheet?

According to the last reported balance sheet, Henan Lantian GasLtd had liabilities of CN¥1.30b due within 12 months, and liabilities of CN¥1.22b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.24b as well as receivables valued at CN¥215.5m due within 12 months. So its liabilities total CN¥1.07b more than the combination of its cash and short-term receivables.

Since publicly traded Henan Lantian GasLtd shares are worth a total of CN¥8.56b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Henan Lantian GasLtd has a very light debt load indeed.

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.

Henan Lantian GasLtd has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.081 and EBIT of 22.8 times the interest expense. So relative to past earnings, the debt load seems trivial. On the other hand, Henan Lantian GasLtd saw its EBIT drop by 4.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Henan Lantian GasLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Henan Lantian GasLtd recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Henan Lantian GasLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. It's also worth noting that Henan Lantian GasLtd is in the Gas Utilities industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Henan Lantian GasLtd is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Henan Lantian GasLtd 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.