Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 China Nonferrous Metal Industry's Foreign Engineering and Construction Co.,Ltd. (SZSE:000758) makes use of debt. But the real question is whether this debt is making the company risky.
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
You can click the graphic below for the historical numbers, but it shows that China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd had CN¥4.92b of debt in June 2024, down from CN¥6.04b, one year before. However, it does have CN¥3.84b in cash offsetting this, leading to net debt of about CN¥1.08b.
We can see from the most recent balance sheet that China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd had liabilities of CN¥7.39b falling due within a year, and liabilities of CN¥3.29b due beyond that. On the other hand, it had cash of CN¥3.84b and CN¥2.85b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.99b.
China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd has a market capitalization of CN¥9.29b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
We'd say that China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its strong interest cover of 10.4 times, makes us even more comfortable. Importantly, China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's EBIT fell a jaw-dropping 43% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Over time, share prices tend to follow earnings per share, so if you're interested in China Nonferrous Metal Industry's Foreign Engineering and ConstructionLtd, you may well want to click here to check an interactive graph of its earnings per share history.
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.