Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Shaanxi Heimao Coking Co., Ltd. (SHSE:601015) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Shaanxi Heimao Coking's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shaanxi Heimao Coking had CN¥4.42b of debt, an increase on CN¥4.22b, over one year. However, because it has a cash reserve of CN¥2.34b, its net debt is less, at about CN¥2.08b.
A Look At Shaanxi Heimao Coking's Liabilities
Zooming in on the latest balance sheet data, we can see that Shaanxi Heimao Coking had liabilities of CN¥9.83b due within 12 months and liabilities of CN¥2.10b due beyond that. Offsetting this, it had CN¥2.34b in cash and CN¥543.0m in receivables that were due within 12 months. So its liabilities total CN¥9.05b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of CN¥7.41b, we think shareholders really should watch Shaanxi Heimao Coking's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shaanxi Heimao Coking'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.
Over 12 months, Shaanxi Heimao Coking made a loss at the EBIT level, and saw its revenue drop to CN¥19b, which is a fall of 14%. We would much prefer see growth.
Caveat Emptor
While Shaanxi Heimao Coking's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥206m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥226m. In the meantime, we consider the stock to be risky. 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, we've discovered 1 warning sign for Shaanxi Heimao Coking that you should be aware of before investing here.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.