Is Henan Lantian GasLtd (SHSE:605368) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Henan Lantian Gas Co.,Ltd. (SHSE:605368) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

Check out our latest analysis for Henan Lantian GasLtd

What Is Henan Lantian GasLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Henan Lantian GasLtd had CN¥1.38b of debt, an increase on CN¥808.3m, over one year. However, it does have CN¥1.73b in cash offsetting this, leading to net cash of CN¥352.2m.

How Healthy Is Henan Lantian GasLtd's Balance Sheet?

We can see from the most recent balance sheet that Henan Lantian GasLtd had liabilities of CN¥1.28b falling due within a year, and liabilities of CN¥1.31b due beyond that. Offsetting this, it had CN¥1.73b in cash and CN¥222.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥636.3m.

Of course, Henan Lantian GasLtd has a market capitalization of CN¥9.24b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Henan Lantian GasLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Henan Lantian GasLtd has increased its EBIT by 3.0% 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Henan Lantian GasLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Henan Lantian GasLtd's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Henan Lantian GasLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥352.2m. On top of that, it increased its EBIT by 3.0% in the last twelve months. So we don't have any problem with Henan Lantian GasLtd's use of debt. 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. Be aware that Henan Lantian GasLtd is showing 1 warning sign in our investment analysis , you should know about...

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.

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