Here's Why Nan Nan Resources Enterprise (HKG:1229) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Nan Nan Resources Enterprise Limited (HKG:1229) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Nan Nan Resources Enterprise

How Much Debt Does Nan Nan Resources Enterprise Carry?

As you can see below, Nan Nan Resources Enterprise had HK$219.8m of debt at March 2022, down from HK$234.3m a year prior. But on the other hand it also has HK$260.8m in cash, leading to a HK$41.0m net cash position.

A Look At Nan Nan Resources Enterprise's Liabilities

According to the last reported balance sheet, Nan Nan Resources Enterprise had liabilities of HK$307.0m due within 12 months, and liabilities of HK$85.1m due beyond 12 months. Offsetting these obligations, it had cash of HK$260.8m as well as receivables valued at HK$5.31m due within 12 months. So its liabilities total HK$126.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Nan Nan Resources Enterprise has a market capitalization of HK$260.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Nan Nan Resources Enterprise boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Nan Nan Resources Enterprise grew its EBIT by 501% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Nan Nan Resources Enterprise 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, a company can only pay off debt with cold hard cash, not accounting profits. Nan Nan Resources Enterprise 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. In the last two years, Nan Nan Resources Enterprise's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While Nan Nan Resources Enterprise does have more liabilities than liquid assets, it also has net cash of HK$41.0m. And we liked the look of last year's 501% year-on-year EBIT growth. So we are not troubled with Nan Nan Resources Enterprise's debt use. 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 example Nan Nan Resources Enterprise has 3 warning signs (and 2 which shouldn't be ignored) we think 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.