We Think China Nonferrous Mining (HKG:1258) Can Stay On Top Of Its Debt

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.' 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 can see that China Nonferrous Mining Corporation Limited (HKG:1258) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China Nonferrous Mining

How Much Debt Does China Nonferrous Mining Carry?

You can click the graphic below for the historical numbers, but it shows that China Nonferrous Mining had US$1.03b of debt in June 2021, down from US$1.36b, one year before. However, because it has a cash reserve of US$841.2m, its net debt is less, at about US$185.7m.

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$1.12b falling due within a year, and liabilities of US$1.11b due beyond that. Offsetting these obligations, it had cash of US$841.2m as well as receivables valued at US$814.8m due within 12 months. So it has liabilities totalling US$573.6m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since China Nonferrous Mining has a market capitalization of US$1.72b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

China Nonferrous Mining has a low net debt to EBITDA ratio of only 0.18. And its EBIT covers its interest expense a whopping 21.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that China Nonferrous Mining grew its EBIT by 165% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Nonferrous Mining's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, China Nonferrous Mining recorded free cash flow of 20% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, China Nonferrous Mining's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that China Nonferrous Mining takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. To that end, you should be aware of the 4 warning signs we've spotted with China Nonferrous Mining .

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.

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.

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