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. As with many other companies Top Energy Company Ltd.Shanxi (SHSE:600780) makes use of debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Top Energy CompanyShanxi
As you can see below, Top Energy CompanyShanxi had CN¥346.3m of debt at June 2024, down from CN¥506.3m a year prior. But it also has CN¥2.46b in cash to offset that, meaning it has CN¥2.12b net cash.
Zooming in on the latest balance sheet data, we can see that Top Energy CompanyShanxi had liabilities of CN¥2.34b due within 12 months and liabilities of CN¥636.5m due beyond that. On the other hand, it had cash of CN¥2.46b and CN¥925.7m worth of receivables due within a year. So it can boast CN¥410.3m more liquid assets than total liabilities.
This surplus suggests that Top Energy CompanyShanxi has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Top Energy CompanyShanxi has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Top Energy CompanyShanxi if management cannot prevent a repeat of the 37% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Top Energy CompanyShanxi'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. Top Energy CompanyShanxi 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. Happily for any shareholders, Top Energy CompanyShanxi actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case Top Energy CompanyShanxi has CN¥2.12b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥669m, being 132% of its EBIT. So we don't have any problem with Top Energy CompanyShanxi's use of debt. 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. Case in point: We've spotted 1 warning sign for Top Energy CompanyShanxi you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.