Is Wuxi Huaguang Environment & Energy GroupLtd (SHSE:600475) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Wuxi Huaguang Environment & Energy Group Co.,Ltd. (SHSE:600475) does carry debt. But the real question is whether this debt is making the company risky.

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Wuxi Huaguang Environment & Energy GroupLtd

What Is Wuxi Huaguang Environment & Energy GroupLtd's Debt?

As you can see below, at the end of September 2023, Wuxi Huaguang Environment & Energy GroupLtd had CN¥7.25b of debt, up from CN¥4.22b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥3.49b, its net debt is less, at about CN¥3.76b.

How Healthy Is Wuxi Huaguang Environment & Energy GroupLtd's Balance Sheet?

The latest balance sheet data shows that Wuxi Huaguang Environment & Energy GroupLtd had liabilities of CN¥9.74b due within a year, and liabilities of CN¥6.23b falling due after that. Offsetting these obligations, it had cash of CN¥3.49b as well as receivables valued at CN¥6.28b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.20b.

This deficit is considerable relative to its market capitalization of CN¥9.79b, so it does suggest shareholders should keep an eye on Wuxi Huaguang Environment & Energy GroupLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Wuxi Huaguang Environment & Energy GroupLtd has a debt to EBITDA ratio of 2.9, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. We note that Wuxi Huaguang Environment & Energy GroupLtd grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Wuxi Huaguang Environment & Energy GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Wuxi Huaguang Environment & Energy GroupLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Neither Wuxi Huaguang Environment & Energy GroupLtd's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Wuxi Huaguang Environment & Energy GroupLtd is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Wuxi Huaguang Environment & Energy GroupLtd you should know about.

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.