Is Qian Jiang Water Resources DevelopmentLtd (SHSE:600283) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Qian Jiang Water Resources Development Co.,Ltd (SHSE:600283) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Qian Jiang Water Resources DevelopmentLtd

What Is Qian Jiang Water Resources DevelopmentLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Qian Jiang Water Resources DevelopmentLtd had debt of CN¥3.44b, up from CN¥1.69b in one year. However, it also had CN¥681.2m in cash, and so its net debt is CN¥2.76b.

A Look At Qian Jiang Water Resources DevelopmentLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Qian Jiang Water Resources DevelopmentLtd had liabilities of CN¥3.52b due within 12 months and liabilities of CN¥2.57b due beyond that. Offsetting these obligations, it had cash of CN¥681.2m as well as receivables valued at CN¥748.3m due within 12 months. So its liabilities total CN¥4.66b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥4.97b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Qian Jiang Water Resources DevelopmentLtd has net debt to EBITDA of 4.5 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 8.6 suggests it can easily service that debt. It is well worth noting that Qian Jiang Water Resources DevelopmentLtd's EBIT shot up like bamboo after rain, gaining 36% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Qian Jiang Water Resources DevelopmentLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Qian Jiang Water Resources DevelopmentLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Qian Jiang Water Resources DevelopmentLtd'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 grow its EBIT with ease. We should also note that Water Utilities industry companies like Qian Jiang Water Resources DevelopmentLtd commonly do use debt without problems. Taking the abovementioned factors together we do think Qian Jiang Water Resources DevelopmentLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 Qian Jiang Water Resources DevelopmentLtd (1 is significant!) that you should be aware of before investing here.

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.