Warren Buffett famously said, '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. Importantly, China Shenhua Energy Company Limited (HKG:1088) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does China Shenhua Energy Carry?
As you can see below, China Shenhua Energy had CN¥53.4b of debt at March 2019, down from CN¥93.8b a year prior. However, it does have CN¥81.9b in cash offsetting this, leading to net cash of CN¥28.5b.
How Strong Is China Shenhua Energy's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Shenhua Energy had liabilities of CN¥93.2b due within 12 months and liabilities of CN¥54.6b due beyond that. Offsetting these obligations, it had cash of CN¥81.9b as well as receivables valued at CN¥14.4b due within 12 months. So its liabilities total CN¥51.4b more than the combination of its cash and short-term receivables.
Given China Shenhua Energy has a humongous market capitalization of CN¥349.8b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, China Shenhua Energy boasts net cash, so it's fair to say it does not have a heavy debt load!
China Shenhua Energy's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Shenhua Energy can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. China Shenhua Energy 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, China Shenhua Energy recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While China Shenhua Energy does have more liabilities than liquid assets, it also has net cash of CN¥28b. And it impressed us with free cash flow of CN¥85b, being 99% of its EBIT. So we don't think China Shenhua Energy's use of debt is risky. Given China Shenhua Energy has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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