We Think Henan Jinma Energy (HKG:6885) Can Stay On Top Of Its Debt

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.' 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 Henan Jinma Energy Company Limited (HKG:6885) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See 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. Offsetting this, it had CN¥1.70b in cash and CN¥108.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥990.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Henan Jinma Energy has a market capitalization of CN¥1.91b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 38% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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 38% year-on-year EBIT growth. So we don't have any problem with Henan Jinma Energy's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Henan Jinma Energy , and understanding them should be part of your investment process.

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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