Is Huaneng Lancang River Hydropower (SHSE:600025) Using Too Much Debt?

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.' 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 Huaneng Lancang River Hydropower Inc. (SHSE:600025) 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?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Huaneng Lancang River Hydropower

How Much Debt Does Huaneng Lancang River Hydropower Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Huaneng Lancang River Hydropower had CN¥116.2b of debt, an increase on CN¥109.5b, over one year. On the flip side, it has CN¥3.02b in cash leading to net debt of about CN¥113.1b.

A Look At Huaneng Lancang River Hydropower's Liabilities

According to the last reported balance sheet, Huaneng Lancang River Hydropower had liabilities of CN¥28.9b due within 12 months, and liabilities of CN¥97.4b due beyond 12 months. On the other hand, it had cash of CN¥3.02b and CN¥3.40b worth of receivables due within a year. So it has liabilities totalling CN¥119.9b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of CN¥161.1b, so it does suggest shareholders should keep an eye on Huaneng Lancang River Hydropower's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Huaneng Lancang River Hydropower has a rather high debt to EBITDA ratio of 6.2 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 5.4 times, suggesting it can responsibly service its obligations. Huaneng Lancang River Hydropower grew its EBIT by 7.3% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Huaneng Lancang River Hydropower can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Huaneng Lancang River Hydropower's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Huaneng Lancang River Hydropower's net debt to EBITDA was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Huaneng Lancang River Hydropower's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Huaneng Lancang River Hydropower has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.