Henan Jinma Energy (HKG:6885) Has A Pretty 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 Henan Jinma Energy Company Limited (HKG:6885) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Henan Jinma Energy

What Is Henan Jinma Energy's Debt?

As you can see below, at the end of June 2020, Henan Jinma Energy had CN¥1.00b of debt, up from CN¥907.4m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.47b in cash, so it actually has CN¥1.47b net cash.

How Strong Is Henan Jinma Energy's Balance Sheet?

The latest balance sheet data shows that Henan Jinma Energy had liabilities of CN¥2.10b due within a year, and liabilities of CN¥500.9m falling due after that. Offsetting these obligations, it had cash of CN¥2.47b as well as receivables valued at CN¥336.6m due within 12 months. So it actually has CN¥211.5m more liquid assets than total liabilities.

This excess liquidity suggests that Henan Jinma Energy is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Henan Jinma Energy has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Henan Jinma Energy if management cannot prevent a repeat of the 36% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Henan Jinma Energy 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 company can only pay off debt with cold hard cash, not accounting profits. Henan Jinma Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Henan Jinma Energy recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Henan Jinma Energy has CN¥1.47b in net cash and a decent-looking balance sheet. So we don't have any problem with Henan Jinma Energy's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Henan Jinma Energy 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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