Here's Why China Daye Non-Ferrous Metals Mining (HKG:661) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China Daye Non-Ferrous Metals Mining Limited (HKG:661) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 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 China Daye Non-Ferrous Metals Mining

How Much Debt Does China Daye Non-Ferrous Metals Mining Carry?

The image below, which you can click on for greater detail, shows that at December 2021 China Daye Non-Ferrous Metals Mining had debt of CN¥9.25b, up from CN¥8.06b in one year. However, it also had CN¥1.21b in cash, and so its net debt is CN¥8.03b.

How Strong Is China Daye Non-Ferrous Metals Mining's Balance Sheet?

According to the last reported balance sheet, China Daye Non-Ferrous Metals Mining had liabilities of CN¥7.04b due within 12 months, and liabilities of CN¥5.94b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.21b as well as receivables valued at CN¥83.4m due within 12 months. So its liabilities total CN¥11.7b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥1.35b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Daye Non-Ferrous Metals Mining would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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).

With a net debt to EBITDA ratio of 5.5, it's fair to say China Daye Non-Ferrous Metals Mining does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 2.8 times, suggesting it can responsibly service its obligations. Looking on the bright side, China Daye Non-Ferrous Metals Mining boosted its EBIT by a silky 40% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Daye Non-Ferrous Metals Mining 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, China Daye Non-Ferrous Metals Mining 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

While China Daye Non-Ferrous Metals Mining's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Taking the abovementioned factors together we do think China Daye Non-Ferrous Metals Mining's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China Daye Non-Ferrous Metals Mining that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.