We Think Zhejiang Zheneng Electric Power (SHSE:600023) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Zhejiang Zheneng Electric Power Co., Ltd. (SHSE:600023) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

What Is Zhejiang Zheneng Electric Power's Debt?

You can click the graphic below for the historical numbers, but it shows that Zhejiang Zheneng Electric Power had CN¥46.4b of debt in September 2024, down from CN¥49.3b, one year before. On the flip side, it has CN¥19.0b in cash leading to net debt of about CN¥27.4b.

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

Zooming in on the latest balance sheet data, we can see that Zhejiang Zheneng Electric Power had liabilities of CN¥36.1b due within 12 months and liabilities of CN¥31.1b due beyond that. Offsetting these obligations, it had cash of CN¥19.0b as well as receivables valued at CN¥14.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥33.5b.

Zhejiang Zheneng Electric Power has a very large market capitalization of CN¥77.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

View our latest analysis for Zhejiang Zheneng Electric Power

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's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. Notably, Zhejiang Zheneng Electric Power's EBIT launched higher than Elon Musk, gaining a whopping 320% on last year. 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 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last two years, Zhejiang Zheneng Electric Power's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Zhejiang Zheneng Electric Power's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. On the other hand, its conversion of EBIT to free cash flow makes us a little less comfortable about its debt. Considering this range of data points, we think Zhejiang Zheneng Electric Power 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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Zhejiang Zheneng Electric Power you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.