Is Xinjiang Xinxin Mining Industry (HKG:3833) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Xinjiang Xinxin Mining Industry Co., Ltd. (HKG:3833) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Xinjiang Xinxin Mining Industry

What Is Xinjiang Xinxin Mining Industry's Debt?

The chart below, which you can click on for greater detail, shows that Xinjiang Xinxin Mining Industry had CN¥1.84b in debt in June 2021; about the same as the year before. However, because it has a cash reserve of CN¥555.0m, its net debt is less, at about CN¥1.28b.

A Look At Xinjiang Xinxin Mining Industry's Liabilities

The latest balance sheet data shows that Xinjiang Xinxin Mining Industry had liabilities of CN¥2.03b due within a year, and liabilities of CN¥640.4m falling due after that. Offsetting this, it had CN¥555.0m in cash and CN¥232.5m in receivables that were due within 12 months. So its liabilities total CN¥1.88b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥2.70b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

Xinjiang Xinxin Mining Industry's net debt of 1.6 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 8.7 times its interest expenses harmonizes with that theme. Even more impressive was the fact that Xinjiang Xinxin Mining Industry grew its EBIT by 450% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xinjiang Xinxin Mining Industry 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Xinjiang Xinxin Mining Industry actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Xinjiang Xinxin Mining Industry's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Xinjiang Xinxin Mining Industry takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 - Xinjiang Xinxin Mining Industry has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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