Is Qingdao Huicheng Environmental Technology Group (SZSE:300779) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Qingdao Huicheng Environmental Technology Group Co., Ltd. (SZSE:300779) does use debt in its business. But should shareholders be worried about its use of debt?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Qingdao Huicheng Environmental Technology Group

What Is Qingdao Huicheng Environmental Technology Group's Net Debt?

As you can see below, at the end of September 2024, Qingdao Huicheng Environmental Technology Group had CN¥2.00b of debt, up from CN¥1.34b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥320.8m, its net debt is less, at about CN¥1.68b.

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¥1.33b due within a year, and liabilities of CN¥1.51b falling due after that. On the other hand, it had cash of CN¥320.8m and CN¥339.8m worth of receivables due within a year. So its liabilities total CN¥2.18b more than the combination of its cash and short-term receivables.

Since publicly traded Qingdao Huicheng Environmental Technology Group shares are worth a total of CN¥20.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.8 times and a disturbingly high net debt to EBITDA ratio of 5.5 hit our confidence in Qingdao Huicheng Environmental Technology Group like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Qingdao Huicheng Environmental Technology Group saw its EBIT tank 48% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Qingdao Huicheng Environmental Technology Group 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

To be frank both Qingdao Huicheng Environmental Technology Group's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. We're quite clear that we consider Qingdao Huicheng Environmental Technology Group to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Qingdao Huicheng Environmental Technology Group (of which 2 don't sit too well with us!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.