Does Nan Nan Resources Enterprise (HKG:1229) Have A Healthy Balance Sheet?

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 can see that Nan Nan Resources Enterprise Limited (HKG:1229) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Nan Nan Resources Enterprise

What Is Nan Nan Resources Enterprise's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Nan Nan Resources Enterprise had debt of HK$234.3m, up from HK$216.4m in one year. On the flip side, it has HK$204.1m in cash leading to net debt of about HK$30.2m.

A Look At Nan Nan Resources Enterprise's Liabilities

Zooming in on the latest balance sheet data, we can see that Nan Nan Resources Enterprise had liabilities of HK$152.7m due within 12 months and liabilities of HK$257.9m due beyond that. Offsetting these obligations, it had cash of HK$204.1m as well as receivables valued at HK$7.61m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$198.9m.

This deficit casts a shadow over the HK$81.9m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Nan Nan Resources Enterprise would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Nan Nan Resources Enterprise's low debt to EBITDA ratio of 0.88 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that Nan Nan Resources Enterprise improved its EBIT from a last year's loss to a positive HK$26m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nan Nan Resources Enterprise 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Nan Nan Resources Enterprise recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We'd go so far as to say Nan Nan Resources Enterprise's level of total liabilities was disappointing. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Overall, it seems to us that Nan Nan Resources Enterprise's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For instance, we've identified 3 warning signs for Nan Nan Resources Enterprise (1 is a bit concerning) you should be aware of.

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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