Wuxi Huaguang Environment & Energy GroupLtd (SHSE:600475) Has A Somewhat Strained Balance Sheet

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.' 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. We can see that Wuxi Huaguang Environment & Energy Group Co.,Ltd. (SHSE:600475) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Wuxi Huaguang Environment & Energy GroupLtd

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

As you can see below, at the end of March 2024, Wuxi Huaguang Environment & Energy GroupLtd had CN¥7.76b of debt, up from CN¥6.14b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥3.13b, its net debt is less, at about CN¥4.63b.

A Look At Wuxi Huaguang Environment & Energy GroupLtd's Liabilities

We can see from the most recent balance sheet that Wuxi Huaguang Environment & Energy GroupLtd had liabilities of CN¥9.60b falling due within a year, and liabilities of CN¥6.07b due beyond that. Offsetting this, it had CN¥3.13b in cash and CN¥5.68b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.85b.

This deficit is considerable relative to its market capitalization of CN¥8.17b, so it does suggest shareholders should keep an eye on Wuxi Huaguang Environment & Energy GroupLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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's net debt is 3.5 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 4k is very high, suggesting that the interest expense on the debt is currently quite low. Wuxi Huaguang Environment & Energy GroupLtd grew its EBIT by 3.5% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wuxi Huaguang Environment & Energy GroupLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Wuxi Huaguang Environment & Energy GroupLtd's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Wuxi Huaguang Environment & Energy GroupLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Wuxi Huaguang Environment & Energy GroupLtd (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com