Is China Coal Energy (HKG:1898) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that China Coal Energy Company Limited (HKG:1898) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Coal Energy

How Much Debt Does China Coal Energy Carry?

As you can see below, China Coal Energy had CN¥74.1b of debt at September 2023, down from CN¥85.6b a year prior. However, its balance sheet shows it holds CN¥89.6b in cash, so it actually has CN¥15.6b net cash.

How Strong Is China Coal Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Coal Energy had liabilities of CN¥93.1b due within 12 months and liabilities of CN¥72.1b due beyond that. Offsetting this, it had CN¥89.6b in cash and CN¥20.6b in receivables that were due within 12 months. So it has liabilities totalling CN¥55.0b more than its cash and near-term receivables, combined.

China Coal Energy has a very large market capitalization of CN¥104.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, China Coal Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact China Coal Energy's saving grace is its low debt levels, because its EBIT has tanked 39% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Coal Energy can strengthen its balance sheet over time. 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 Coal 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 Coal Energy generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While China Coal Energy does have more liabilities than liquid assets, it also has net cash of CN¥15.6b. And it impressed us with free cash flow of CN¥24b, being 98% of its EBIT. So we are not troubled with China Coal Energy's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for China Coal Energy you should be aware of.

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.