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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shanxi Meijin Energy Co.,Ltd. (SZSE:000723) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

What Is Shanxi Meijin EnergyLtd's Net Debt?

As you can see below, at the end of September 2023, Shanxi Meijin EnergyLtd had CN¥5.84b of debt, up from CN¥5.37b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥5.89b in cash, so it actually has CN¥42.6m net cash.

How Healthy Is Shanxi Meijin EnergyLtd's Balance Sheet?

We can see from the most recent balance sheet that Shanxi Meijin EnergyLtd had liabilities of CN¥15.9b falling due within a year, and liabilities of CN¥7.04b due beyond that. Offsetting this, it had CN¥5.89b in cash and CN¥2.55b in receivables that were due within 12 months. So its liabilities total CN¥14.5b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Shanxi Meijin EnergyLtd is worth CN¥29.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Shanxi Meijin EnergyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Shanxi Meijin EnergyLtd's EBIT was down 54% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanxi Meijin EnergyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shanxi Meijin EnergyLtd 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. Considering the last three years, Shanxi Meijin EnergyLtd actually recorded a cash outflow, overall. 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 Shanxi Meijin EnergyLtd does have more liabilities than liquid assets, it also has net cash of CN¥42.6m. Despite its cash we think that Shanxi Meijin EnergyLtd seems to struggle to grow its EBIT, so we are wary of the stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shanxi Meijin EnergyLtd (of which 1 makes us a bit uncomfortable!) you should know about.

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.