Does Ximei Resources Holding (HKG:9936) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Ximei Resources Holding Limited (HKG:9936) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Ximei Resources Holding

What Is Ximei Resources Holding's Debt?

As you can see below, Ximei Resources Holding had CN¥230.4m of debt at June 2021, down from CN¥240.9m a year prior. On the flip side, it has CN¥180.4m in cash leading to net debt of about CN¥50.0m.

How Strong Is Ximei Resources Holding's Balance Sheet?

The latest balance sheet data shows that Ximei Resources Holding had liabilities of CN¥296.6m due within a year, and liabilities of CN¥31.3m falling due after that. On the other hand, it had cash of CN¥180.4m and CN¥200.1m worth of receivables due within a year. So it actually has CN¥52.6m more liquid assets than total liabilities.

This surplus suggests that Ximei Resources Holding has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Ximei Resources Holding's net debt is only 0.55 times its EBITDA. And its EBIT covers its interest expense a whopping 10.3 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Ximei Resources Holding if management cannot prevent a repeat of the 21% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ximei Resources Holding 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Ximei Resources Holding burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Ximei Resources Holding's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But on the brighter side of life, its interest cover leaves us feeling more frolicsome. Looking at all the angles mentioned above, it does seem to us that Ximei Resources Holding 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. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

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.