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 Jiangsu Provincial Agricultural Reclamation and Development Co.,Ltd. (SHSE:601952) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd had debt of CN¥5.46b, up from CN¥650.4m in one year. However, it does have CN¥2.42b in cash offsetting this, leading to net debt of about CN¥3.04b.

How Healthy Is Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd's Balance Sheet?

The latest balance sheet data shows that Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd had liabilities of CN¥2.85b due within a year, and liabilities of CN¥4.99b falling due after that. Offsetting these obligations, it had cash of CN¥2.42b as well as receivables valued at CN¥961.6m due within 12 months. So it has liabilities totalling CN¥4.45b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd has a market capitalization of CN¥13.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 4.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Investors should also be troubled by the fact that Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd saw its EBIT drop by 14% over the last twelve months. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd 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.

Our View

On our analysis Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at (not) growing its EBIT as wet socks are at keeping your feet warm. When we consider all the factors mentioned above, we do feel a bit cautious about Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd'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. 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 2 warning signs for Jiangsu Provincial Agricultural Reclamation and DevelopmentLtd you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.