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, Shandong Nanshan Aluminium Co.,Ltd. (SHSE:600219) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 think about a company's use of debt, we first look at cash and debt together.
What Is Shandong Nanshan AluminiumLtd's Debt?
The chart below, which you can click on for greater detail, shows that Shandong Nanshan AluminiumLtd had CN¥7.66b in debt in December 2023; about the same as the year before. However, it does have CN¥26.4b in cash offsetting this, leading to net cash of CN¥18.8b.
How Healthy Is Shandong Nanshan AluminiumLtd's Balance Sheet?
We can see from the most recent balance sheet that Shandong Nanshan AluminiumLtd had liabilities of CN¥14.1b falling due within a year, and liabilities of CN¥675.5m due beyond that. On the other hand, it had cash of CN¥26.4b and CN¥5.95b worth of receivables due within a year. So it actually has CN¥17.6b more liquid assets than total liabilities.
This luscious liquidity implies that Shandong Nanshan AluminiumLtd's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Shandong Nanshan AluminiumLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Shandong Nanshan AluminiumLtd's load is not too heavy, because its EBIT was down 26% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shandong Nanshan AluminiumLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shandong Nanshan AluminiumLtd 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. Over the last three years, Shandong Nanshan AluminiumLtd recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shandong Nanshan AluminiumLtd has CN¥18.8b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.0b, being 88% of its EBIT. So is Shandong Nanshan AluminiumLtd's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Shandong Nanshan AluminiumLtd that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.