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 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. We note that Qingdao Huicheng Environmental Technology Group Co., Ltd. (SZSE:300779) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Qingdao Huicheng Environmental Technology Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2024 Qingdao Huicheng Environmental Technology Group had CN¥1.48b of debt, an increase on CN¥1.27b, over one year. However, because it has a cash reserve of CN¥548.6m, its net debt is less, at about CN¥932.6m.
How Healthy Is Qingdao Huicheng Environmental Technology Group's Balance Sheet?
The latest balance sheet data shows that Qingdao Huicheng Environmental Technology Group had liabilities of CN¥887.2m due within a year, and liabilities of CN¥1.46b falling due after that. Offsetting these obligations, it had cash of CN¥548.6m as well as receivables valued at CN¥332.2m due within 12 months. So its liabilities total CN¥1.47b more than the combination of its cash and short-term receivables.
Given Qingdao Huicheng Environmental Technology Group has a market capitalization of CN¥8.71b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Qingdao Huicheng Environmental Technology Group has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 2.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Qingdao Huicheng Environmental Technology Group grew its EBIT a smooth 38% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Qingdao Huicheng Environmental Technology Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Qingdao Huicheng Environmental Technology Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
Neither Qingdao Huicheng Environmental Technology Group's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Qingdao Huicheng Environmental Technology Group is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. To that end, you should learn about the 3 warning signs we've spotted with Qingdao Huicheng Environmental Technology Group (including 1 which is potentially serious) .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
