Is Xinjiang Lixin Energy (SZSE:001258) A Risky Investment?

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.' 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 Xinjiang Lixin Energy Co., LTD. (SZSE:001258) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Xinjiang Lixin Energy

How Much Debt Does Xinjiang Lixin Energy Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Xinjiang Lixin Energy had CN¥9.07b of debt, an increase on CN¥5.98b, over one year. On the flip side, it has CN¥367.3m in cash leading to net debt of about CN¥8.70b.

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A Look At Xinjiang Lixin Energy's Liabilities

We can see from the most recent balance sheet that Xinjiang Lixin Energy had liabilities of CN¥2.70b falling due within a year, and liabilities of CN¥7.14b due beyond that. On the other hand, it had cash of CN¥367.3m and CN¥2.04b worth of receivables due within a year. So its liabilities total CN¥7.44b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CN¥6.44b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 14.8 hit our confidence in Xinjiang Lixin Energy like a one-two punch to the gut. The debt burden here is substantial. Worse, Xinjiang Lixin Energy's EBIT was down 37% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xinjiang Lixin Energy will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Xinjiang Lixin Energy saw substantial negative free cash flow, in total. 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, Xinjiang Lixin Energy's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate 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. Considering all the factors previously mentioned, we think that Xinjiang Lixin Energy really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. 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. Be aware that Xinjiang Lixin Energy is showing 4 warning signs in our investment analysis , and 3 of those don't sit too well with us...

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.