Is Wuhan Tianyuan Environmental ProtectionLTD (SZSE:301127) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Wuhan Tianyuan Environmental Protection Co.,LTD (SZSE:301127) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Wuhan Tianyuan Environmental ProtectionLTD

How Much Debt Does Wuhan Tianyuan Environmental ProtectionLTD Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Wuhan Tianyuan Environmental ProtectionLTD had debt of CN¥2.13b, up from CN¥1.58b in one year. However, it also had CN¥1.31b in cash, and so its net debt is CN¥820.2m.

How Healthy Is Wuhan Tianyuan Environmental ProtectionLTD's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wuhan Tianyuan Environmental ProtectionLTD had liabilities of CN¥1.28b due within 12 months and liabilities of CN¥2.21b due beyond that. Offsetting this, it had CN¥1.31b in cash and CN¥920.7m in receivables that were due within 12 months. So its liabilities total CN¥1.27b more than the combination of its cash and short-term receivables.

Given Wuhan Tianyuan Environmental ProtectionLTD has a market capitalization of CN¥9.62b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

Wuhan Tianyuan Environmental ProtectionLTD's net debt of 1.9 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 8.7 times its interest expenses harmonizes with that theme. Importantly, Wuhan Tianyuan Environmental ProtectionLTD grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Wuhan Tianyuan Environmental ProtectionLTD'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's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Wuhan Tianyuan Environmental ProtectionLTD burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Wuhan Tianyuan Environmental ProtectionLTD is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. Considering this range of data points, we think Wuhan Tianyuan Environmental ProtectionLTD is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Wuhan Tianyuan Environmental ProtectionLTD (including 2 which can't be ignored) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.