Health Check: How Prudently Does China Natural Resources (NASDAQ:CHNR) Use Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, China Natural Resources, Inc. (NASDAQ:CHNR) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Natural Resources

What Is China Natural Resources's Net Debt?

As you can see below, China Natural Resources had CN¥72.5m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥32.8m in cash, and so its net debt is CN¥39.7m.

How Strong Is China Natural Resources' Balance Sheet?

We can see from the most recent balance sheet that China Natural Resources had liabilities of CN¥325.9m falling due within a year, and liabilities of CN¥75.3m due beyond that. On the other hand, it had cash of CN¥32.8m and CN¥161.8m worth of receivables due within a year. So it has liabilities totalling CN¥206.7m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥92.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Natural Resources would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Natural Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China Natural Resources had a loss before interest and tax, and actually shrunk its revenue by 38%, to CN¥16m. To be frank that doesn't bode well.

Caveat Emptor

While China Natural Resources's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥32m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CN¥6.3m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. Be aware that China Natural Resources is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.