Is Henan Jinma Energy (HKG:6885) Using Too Much Debt?

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.' 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 note that Henan Jinma Energy Company Limited (HKG:6885) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Henan Jinma Energy

How Much Debt Does Henan Jinma Energy Carry?

The chart below, which you can click on for greater detail, shows that Henan Jinma Energy had CN¥1.00b in debt in June 2021; about the same as the year before. But on the other hand it also has CN¥1.70b in cash, leading to a CN¥701.8m net cash position.

How Healthy Is Henan Jinma Energy's Balance Sheet?

The latest balance sheet data shows that Henan Jinma Energy had liabilities of CN¥2.25b due within a year, and liabilities of CN¥550.7m falling due after that. On the other hand, it had cash of CN¥1.70b and CN¥273.4m worth of receivables due within a year. So its liabilities total CN¥825.5m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Henan Jinma Energy is worth CN¥1.83b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Henan Jinma Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Henan Jinma Energy grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle 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 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. In the last three years, Henan Jinma Energy's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While Henan Jinma Energy does have more liabilities than liquid assets, it also has net cash of CN¥701.8m. And we liked the look of last year's 37% year-on-year EBIT growth. So we are not troubled with Henan Jinma Energy's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Henan Jinma Energy (of which 1 shouldn't be ignored!) you should know about.

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.