These 4 Measures Indicate That Jinhui Shipping and Transportation (OB:JIN) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Jinhui Shipping and Transportation Limited (OB:JIN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, 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.

Check out our latest analysis for Jinhui Shipping and Transportation

What Is Jinhui Shipping and Transportation's Net Debt?

The image below, which you can click on for greater detail, shows that Jinhui Shipping and Transportation had debt of US$117.7m at the end of March 2021, a reduction from US$129.7m over a year. However, it does have US$89.4m in cash offsetting this, leading to net debt of about US$28.4m.

How Healthy Is Jinhui Shipping and Transportation's Balance Sheet?

According to the last reported balance sheet, Jinhui Shipping and Transportation had liabilities of US$87.7m due within 12 months, and liabilities of US$48.7m due beyond 12 months. Offsetting this, it had US$89.4m in cash and US$17.5m in receivables that were due within 12 months. So its liabilities total US$29.6m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Jinhui Shipping and Transportation is worth US$110.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jinhui Shipping and Transportation has net debt of just 1.2 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. Although Jinhui Shipping and Transportation made a loss at the EBIT level, last year, it was also good to see that it generated US$9.1m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jinhui Shipping and Transportation's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Jinhui Shipping and Transportation generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Jinhui Shipping and Transportation's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. When we consider the range of factors above, it looks like Jinhui Shipping and Transportation is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Jinhui Shipping and Transportation (including 1 which makes us a bit uncomfortable) .

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. 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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