Is China Daye Non-Ferrous Metals Mining (HKG:661) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Daye Non-Ferrous Metals Mining Limited (HKG:661) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Daye Non-Ferrous Metals Mining

What Is China Daye Non-Ferrous Metals Mining's Debt?

The image below, which you can click on for greater detail, shows that China Daye Non-Ferrous Metals Mining had debt of CN¥8.59b at the end of June 2021, a reduction from CN¥10.6b over a year. However, because it has a cash reserve of CN¥1.94b, its net debt is less, at about CN¥6.65b.

How Healthy 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¥8.00b due within 12 months, and liabilities of CN¥5.01b due beyond 12 months. On the other hand, it had cash of CN¥1.94b and CN¥112.0m worth of receivables due within a year. So its liabilities total CN¥11.0b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥1.78b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Daye Non-Ferrous Metals Mining would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Daye Non-Ferrous Metals Mining has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 3.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, it should be some comfort for shareholders to recall that China Daye Non-Ferrous Metals Mining actually grew its EBIT by a hefty 109%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Daye Non-Ferrous Metals Mining will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding 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. Looking at all the angles mentioned above, it does seem to us that China Daye Non-Ferrous Metals Mining is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for China Daye Non-Ferrous Metals Mining that you should be aware of before investing here.

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.
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