These 4 Measures Indicate That Jinneng Holding Shanxi Electric PowerLTD (SZSE:000767) Is Using Debt In A Risky Way

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Jinneng Holding Shanxi Electric Power Co.,LTD. (SZSE:000767) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Jinneng Holding Shanxi Electric PowerLTD

What Is Jinneng Holding Shanxi Electric PowerLTD's Debt?

The chart below, which you can click on for greater detail, shows that Jinneng Holding Shanxi Electric PowerLTD had CN¥33.8b in debt in June 2024; about the same as the year before. However, it does have CN¥5.34b in cash offsetting this, leading to net debt of about CN¥28.5b.

A Look At Jinneng Holding Shanxi Electric PowerLTD's Liabilities

The latest balance sheet data shows that Jinneng Holding Shanxi Electric PowerLTD had liabilities of CN¥21.0b due within a year, and liabilities of CN¥26.4b falling due after that. Offsetting this, it had CN¥5.34b in cash and CN¥9.75b in receivables that were due within 12 months. So its liabilities total CN¥32.3b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥7.63b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Jinneng Holding Shanxi Electric PowerLTD would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Jinneng Holding Shanxi Electric PowerLTD shareholders face the double whammy of a high net debt to EBITDA ratio (10.4), and fairly weak interest coverage, since EBIT is just 0.18 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Jinneng Holding Shanxi Electric PowerLTD saw its EBIT tank 75% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Jinneng Holding Shanxi Electric PowerLTD 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Jinneng Holding Shanxi Electric PowerLTD burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Jinneng Holding Shanxi Electric PowerLTD's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. It looks to us like Jinneng Holding Shanxi Electric PowerLTD carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. Be aware that Jinneng Holding Shanxi Electric PowerLTD is showing 1 warning sign in our investment analysis , 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.