Does China Nonferrous Mining (HKG:1258) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that China Nonferrous Mining Corporation Limited (HKG:1258) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Nonferrous Mining

What Is China Nonferrous Mining's Debt?

As you can see below, China Nonferrous Mining had US$1.06b of debt at December 2020, down from US$1.20b a year prior. However, it does have US$497.8m in cash offsetting this, leading to net debt of about US$563.6m.

A Look At China Nonferrous Mining's Liabilities

We can see from the most recent balance sheet that China Nonferrous Mining had liabilities of US$1.29b falling due within a year, and liabilities of US$585.3m due beyond that. Offsetting these obligations, it had cash of US$497.8m as well as receivables valued at US$248.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.13b.

Given this deficit is actually higher than the company's market capitalization of US$1.01b, we think shareholders really should watch China Nonferrous Mining's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

China Nonferrous Mining has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 13.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that China Nonferrous Mining has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is China Nonferrous Mining's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, China Nonferrous Mining reported free cash flow worth 3.8% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We feel some trepidation about China Nonferrous Mining's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that China Nonferrous Mining is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - China Nonferrous Mining has 3 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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