These 4 Measures Indicate That Qingdao Huicheng Environmental Technology Group (SZSE:300779) Is Using Debt Extensively

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. As with many other companies Qingdao Huicheng Environmental Technology Group Co., Ltd. (SZSE:300779) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 June 2024, Qingdao Huicheng Environmental Technology Group had CN¥1.76b of debt, up from CN¥1.27b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥548.6m, its net debt is less, at about CN¥1.21b.

A Look At Qingdao Huicheng Environmental Technology Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Qingdao Huicheng Environmental Technology Group had liabilities of CN¥887.2m due within 12 months and liabilities of CN¥1.46b due beyond that. On the other hand, it had cash of CN¥548.6m and CN¥332.2m worth of receivables due within a year. So it has liabilities totalling CN¥1.47b more than its cash and near-term receivables, combined.

Since publicly traded Qingdao Huicheng Environmental Technology Group shares are worth a total of CN¥10.1b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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 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. 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 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 always check how much of that EBIT is translated into free cash flow. Over the last three 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

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 its EBIT growth rate tells a very different story, and suggests some resilience. 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. 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. We've identified 3 warning signs with Qingdao Huicheng Environmental Technology Group (at least 2 which can't be ignored) , 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.

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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.