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 note that Inner Mongolia Yitai Coal Co.,Ltd (SHSE:900948) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
Check out our latest analysis for Inner Mongolia Yitai CoalLtd
How Much Debt Does Inner Mongolia Yitai CoalLtd Carry?
The image below, which you can click on for greater detail, shows that Inner Mongolia Yitai CoalLtd had debt of CN¥16.4b at the end of September 2023, a reduction from CN¥18.2b over a year. But on the other hand it also has CN¥21.1b in cash, leading to a CN¥4.74b net cash position.
How Healthy Is Inner Mongolia Yitai CoalLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Inner Mongolia Yitai CoalLtd had liabilities of CN¥14.1b due within 12 months and liabilities of CN¥16.0b due beyond that. Offsetting this, it had CN¥21.1b in cash and CN¥1.63b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.32b.
While this might seem like a lot, it is not so bad since Inner Mongolia Yitai CoalLtd has a market capitalization of CN¥34.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Inner Mongolia Yitai CoalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Inner Mongolia Yitai CoalLtd if management cannot prevent a repeat of the 35% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Inner Mongolia Yitai CoalLtd'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Inner Mongolia Yitai CoalLtd 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, Inner Mongolia Yitai CoalLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
Although Inner Mongolia Yitai CoalLtd'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¥4.74b. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in CN¥11b. So we don't have any problem with Inner Mongolia Yitai CoalLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Inner Mongolia Yitai CoalLtd you should be aware of.
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.