Here's Why Jilin Province Chuncheng Heating (HKG:1853) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Jilin Province Chuncheng Heating Company Limited (HKG:1853) 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?

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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Jilin Province Chuncheng Heating

What Is Jilin Province Chuncheng Heating's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Jilin Province Chuncheng Heating had CN¥379.0m of debt, an increase on CN¥2.62m, over one year. However, its balance sheet shows it holds CN¥392.1m in cash, so it actually has CN¥13.1m net cash.

A Look At Jilin Province Chuncheng Heating's Liabilities

The latest balance sheet data shows that Jilin Province Chuncheng Heating had liabilities of CN¥1.25b due within a year, and liabilities of CN¥122.8m falling due after that. Offsetting this, it had CN¥392.1m in cash and CN¥341.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥635.2m.

This is a mountain of leverage relative to its market capitalization of CN¥824.9m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Jilin Province Chuncheng Heating boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Jilin Province Chuncheng Heating's load is not too heavy, because its EBIT was down 70% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Jilin Province Chuncheng Heating 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Jilin Province Chuncheng Heating 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. Over the last three years, Jilin Province Chuncheng Heating reported free cash flow worth 17% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

Although Jilin Province Chuncheng Heating's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥13.1m. So although we see some areas for improvement, we're not too worried about Jilin Province Chuncheng Heating's balance sheet. 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. For example Jilin Province Chuncheng Heating has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.