Is Beijing Capital Eco-Environment Protection Group (SHSE:600008) Using Too Much Debt?

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 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. We can see that Beijing Capital Eco-Environment Protection Group Co., Ltd. (SHSE:600008) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Beijing Capital Eco-Environment Protection Group

What Is Beijing Capital Eco-Environment Protection Group's Debt?

As you can see below, at the end of September 2024, Beijing Capital Eco-Environment Protection Group had CN¥51.7b of debt, up from CN¥49.2b a year ago. Click the image for more detail. However, it also had CN¥4.93b in cash, and so its net debt is CN¥46.8b.

How Strong Is Beijing Capital Eco-Environment Protection Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Beijing Capital Eco-Environment Protection Group had liabilities of CN¥29.4b due within 12 months and liabilities of CN¥41.0b due beyond that. Offsetting this, it had CN¥4.93b in cash and CN¥21.4b in receivables that were due within 12 months. So it has liabilities totalling CN¥44.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥22.3b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Beijing Capital Eco-Environment Protection Group would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Beijing Capital Eco-Environment Protection Group has a fairly concerning net debt to EBITDA ratio of 6.0 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Beijing Capital Eco-Environment Protection Group grew its EBIT by 4.2% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Beijing Capital Eco-Environment Protection 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Beijing Capital Eco-Environment Protection Group 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

On the face of it, Beijing Capital Eco-Environment Protection Group's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that Beijing Capital Eco-Environment Protection Group is in the Water Utilities industry, which is often considered to be quite defensive. Overall, it seems to us that Beijing Capital Eco-Environment Protection Group's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For example Beijing Capital Eco-Environment Protection Group has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

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.