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. As with many other companies CECEP Techand Ecology&Environment Co.,Ltd. (SZSE:300197) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does CECEP Techand Ecology&EnvironmentLtd Carry?
As you can see below, at the end of September 2023, CECEP Techand Ecology&EnvironmentLtd had CN¥17.4b of debt, up from CN¥16.5b a year ago. Click the image for more detail. However, it does have CN¥3.13b in cash offsetting this, leading to net debt of about CN¥14.2b.
How Healthy Is CECEP Techand Ecology&EnvironmentLtd's Balance Sheet?
According to the last reported balance sheet, CECEP Techand Ecology&EnvironmentLtd had liabilities of CN¥17.3b due within 12 months, and liabilities of CN¥7.90b due beyond 12 months. Offsetting this, it had CN¥3.13b in cash and CN¥9.09b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥13.0b.
This deficit casts a shadow over the CN¥5.81b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, CECEP Techand Ecology&EnvironmentLtd would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is CECEP Techand Ecology&EnvironmentLtd's earnings that will influence how the balance sheet holds up in the future. 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.
Over 12 months, CECEP Techand Ecology&EnvironmentLtd reported revenue of CN¥2.7b, which is a gain of 8.8%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Importantly, CECEP Techand Ecology&EnvironmentLtd had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥631m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CN¥595m over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with CECEP Techand Ecology&EnvironmentLtd (at least 2 which are significant) , and understanding them should be part of your investment process.
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.
