Is Qingdao Huicheng Environmental Technology Group (SZSE:300779) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Qingdao Huicheng Environmental Technology Group Co., Ltd. (SZSE:300779) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Qingdao Huicheng Environmental Technology Group

How Much Debt Does Qingdao Huicheng Environmental Technology Group Carry?

As you can see below, at the end of September 2023, Qingdao Huicheng Environmental Technology Group had CN¥1.34b of debt, up from CN¥1.12b a year ago. Click the image for more detail. On the flip side, it has CN¥500.7m in cash leading to net debt of about CN¥842.6m.

A Look At Qingdao Huicheng Environmental Technology Group's Liabilities

According to the last reported balance sheet, Qingdao Huicheng Environmental Technology Group had liabilities of CN¥810.8m due within 12 months, and liabilities of CN¥1.14b due beyond 12 months. Offsetting these obligations, it had cash of CN¥500.7m as well as receivables valued at CN¥324.8m due within 12 months. So it has liabilities totalling CN¥1.12b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Qingdao Huicheng Environmental Technology Group has a market capitalization of CN¥5.43b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Qingdao Huicheng Environmental Technology Group has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 5.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We also note that Qingdao Huicheng Environmental Technology Group improved its EBIT from a last year's loss to a positive CN¥188m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Qingdao Huicheng Environmental Technology Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, 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

Qingdao Huicheng Environmental Technology Group's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its level of total liabilities is relatively strong. When we consider all the factors discussed, it seems to us that Qingdao Huicheng Environmental Technology Group is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should learn about the 3 warning signs we've spotted with Qingdao Huicheng Environmental Technology Group (including 2 which make us uncomfortable) .

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.

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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.