We Think China Shenhua Energy (HKG:1088) Can Manage Its Debt With Ease

Warren Buffett famously said, '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 China Shenhua Energy Company Limited (HKG:1088) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. 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 China Shenhua Energy

How Much Debt Does China Shenhua Energy Carry?

You can click the graphic below for the historical numbers, but it shows that China Shenhua Energy had CN¥54.5b of debt in December 2022, down from CN¥62.3b, one year before. But on the other hand it also has CN¥164.6b in cash, leading to a CN¥110.1b net cash position.

A Look At China Shenhua Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that China Shenhua Energy had liabilities of CN¥98.4b due within 12 months and liabilities of CN¥64.1b due beyond that. On the other hand, it had cash of CN¥164.6b and CN¥17.7b worth of receivables due within a year. So it can boast CN¥19.9b more liquid assets than total liabilities.

This surplus suggests that China Shenhua Energy has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that China Shenhua Energy has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, China Shenhua Energy grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Shenhua Energy's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Shenhua Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, China Shenhua Energy generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Shenhua Energy has net cash of CN¥110.1b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥83b, being 88% of its EBIT. So is China Shenhua Energy's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Shenhua Energy (of which 1 can't be ignored!) 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.