Here's Why Zhejiang Zheneng Electric Power (SHSE:600023) Has A Meaningful Debt Burden

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zhejiang Zheneng Electric Power Co., Ltd. (SHSE:600023) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Zhejiang Zheneng Electric Power

What Is Zhejiang Zheneng Electric Power's Debt?

As you can see below, at the end of September 2023, Zhejiang Zheneng Electric Power had CN¥49.3b of debt, up from CN¥38.3b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥19.8b, its net debt is less, at about CN¥29.5b.

A Look At Zhejiang Zheneng Electric Power's Liabilities

We can see from the most recent balance sheet that Zhejiang Zheneng Electric Power had liabilities of CN¥31.5b falling due within a year, and liabilities of CN¥35.8b due beyond that. Offsetting these obligations, it had cash of CN¥19.8b as well as receivables valued at CN¥15.0b due within 12 months. So its liabilities total CN¥32.5b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhejiang Zheneng Electric Power is worth a massive CN¥81.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Zhejiang Zheneng Electric Power has a debt to EBITDA ratio of 4.1, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. We also note that Zhejiang Zheneng Electric Power improved its EBIT from a last year's loss to a positive CN¥1.5b. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhejiang Zheneng Electric Power can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, Zhejiang Zheneng Electric Power 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

Neither Zhejiang Zheneng Electric Power's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that Zhejiang Zheneng Electric Power is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. Over time, share prices tend to follow earnings per share, so if you're interested in Zhejiang Zheneng Electric Power, you may well want to click here to check an interactive graph of its earnings per share history.

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.