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.' 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 can see that Jiangsu Linyang Energy Co., Ltd. (SHSE:601222) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Jiangsu Linyang Energy
How Much Debt Does Jiangsu Linyang Energy Carry?
As you can see below, at the end of September 2023, Jiangsu Linyang Energy had CN¥3.03b of debt, up from CN¥2.75b a year ago. Click the image for more detail. However, it does have CN¥6.08b in cash offsetting this, leading to net cash of CN¥3.05b.
How Healthy Is Jiangsu Linyang Energy's Balance Sheet?
According to the last reported balance sheet, Jiangsu Linyang Energy had liabilities of CN¥5.16b due within 12 months, and liabilities of CN¥2.69b due beyond 12 months. Offsetting this, it had CN¥6.08b in cash and CN¥4.62b in receivables that were due within 12 months. So it actually has CN¥2.86b more liquid assets than total liabilities.
It's good to see that Jiangsu Linyang Energy has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Jiangsu Linyang Energy has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Jiangsu Linyang Energy grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangsu Linyang Energy can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Jiangsu Linyang 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. Over the last three years, Jiangsu Linyang Energy recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing Up
While it is always sensible to investigate a company's debt, in this case Jiangsu Linyang Energy has CN¥3.05b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 11% over the last year. So we are not troubled with Jiangsu Linyang Energy's debt use. 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. We've identified 1 warning sign with Jiangsu Linyang 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.