The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Liaoning Dingjide Petrochemical Co., Ltd. (SHSE:603255) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Liaoning Dingjide Petrochemical's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Liaoning Dingjide Petrochemical had CN¥211.6m of debt, an increase on CN¥187.9m, over one year. However, its balance sheet shows it holds CN¥511.0m in cash, so it actually has CN¥299.4m net cash.
How Strong Is Liaoning Dingjide Petrochemical's Balance Sheet?
We can see from the most recent balance sheet that Liaoning Dingjide Petrochemical had liabilities of CN¥330.9m falling due within a year, and liabilities of CN¥33.1m due beyond that. On the other hand, it had cash of CN¥511.0m and CN¥378.3m worth of receivables due within a year. So it can boast CN¥525.3m more liquid assets than total liabilities.
This surplus suggests that Liaoning Dingjide Petrochemical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Liaoning Dingjide Petrochemical boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Liaoning Dingjide Petrochemical if management cannot prevent a repeat of the 58% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Liaoning Dingjide Petrochemical will need earnings to service that debt. 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. While Liaoning Dingjide Petrochemical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Liaoning Dingjide Petrochemical burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Liaoning Dingjide Petrochemical has CN¥299.4m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Liaoning Dingjide Petrochemical's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Liaoning Dingjide Petrochemical that 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.