Here's Why Zhejiang Provincial New Energy Investment Group (SHSE:600032) Is Weighed Down By Its Debt Load

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Zhejiang Provincial New Energy Investment Group Co., Ltd. (SHSE:600032) makes use of debt. But should shareholders be worried about its use of debt?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Zhejiang Provincial New Energy Investment Group

What Is Zhejiang Provincial New Energy Investment Group's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Zhejiang Provincial New Energy Investment Group had debt of CN¥28.6b, up from CN¥27.4b in one year. On the flip side, it has CN¥2.42b in cash leading to net debt of about CN¥26.2b.

How Healthy Is Zhejiang Provincial New Energy Investment Group's Balance Sheet?

The latest balance sheet data shows that Zhejiang Provincial New Energy Investment Group had liabilities of CN¥7.76b due within a year, and liabilities of CN¥27.2b falling due after that. Offsetting this, it had CN¥2.42b in cash and CN¥8.08b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥24.5b.

Given this deficit is actually higher than the company's market capitalization of CN¥16.5b, we think shareholders really should watch Zhejiang Provincial New Energy Investment Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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 Provincial New Energy Investment Group has a rather high debt to EBITDA ratio of 7.3 which suggests a meaningful debt load. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. More concerning, Zhejiang Provincial New Energy Investment Group saw its EBIT drop by 2.8% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. 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 Provincial New Energy Investment Group 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.

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, Zhejiang Provincial New Energy Investment Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Zhejiang Provincial New Energy Investment Group's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Zhejiang Provincial New Energy Investment Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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, we've discovered 2 warning signs for Zhejiang Provincial New Energy Investment Group (1 is significant!) that you should be aware of before investing here.

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.