Here's Why CGN Mining (HKG:1164) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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. We note that CGN Mining Company Limited (HKG:1164) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for CGN Mining

What Is CGN Mining's Debt?

The image below, which you can click on for greater detail, shows that at June 2019 CGN Mining had debt of HK$383.9m, up from none in one year. However, its balance sheet shows it holds HK$694.2m in cash, so it actually has HK$310.3m net cash.

How Healthy Is CGN Mining's Balance Sheet?

According to the last reported balance sheet, CGN Mining had liabilities of HK$378.0m due within 12 months, and liabilities of HK$139.2m due beyond 12 months. On the other hand, it had cash of HK$694.2m and HK$88.4m worth of receivables due within a year. So it can boast HK$265.4m more liquid assets than total liabilities.

This surplus suggests that CGN Mining has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that CGN Mining has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that CGN Mining's load is not too heavy, because its EBIT was down 92% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CGN Mining will need earnings to service that debt. 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. CGN Mining 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. During the last three years, CGN Mining generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd 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 CGN Mining has HK$310.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in HK$21m. So we don't have any problem with CGN Mining's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of CGN Mining's earnings per share history for free.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.