We Think Zhejiang Zheneng Electric Power (SHSE:600023) Can Stay On Top Of Its 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 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 Zhejiang Zheneng Electric Power Co., Ltd. (SHSE:600023) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zhejiang Zheneng Electric Power

What Is Zhejiang Zheneng Electric Power's Debt?

As you can see below, Zhejiang Zheneng Electric Power had CN¥48.1b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥19.0b in cash, and so its net debt is CN¥29.1b.

How Healthy Is Zhejiang Zheneng Electric Power's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Zheneng Electric Power had liabilities of CN¥30.2b falling due within a year, and liabilities of CN¥35.2b due beyond that. Offsetting this, it had CN¥19.0b in cash and CN¥14.1b in receivables that were due within 12 months. So its liabilities total CN¥32.3b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Zhejiang Zheneng Electric Power has a huge market capitalization of CN¥102.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Zhejiang Zheneng Electric Power's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. We also note that Zhejiang Zheneng Electric Power improved its EBIT from a last year's loss to a positive CN¥6.3b. 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 Zhejiang Zheneng Electric Power'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Zhejiang Zheneng Electric Power generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Zhejiang Zheneng Electric Power's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. All these things considered, it appears that Zhejiang Zheneng Electric Power can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Zhejiang Zheneng Electric Power that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com