Does DaTang HuaYin Electric PowerLTD (SHSE:600744) Have A Healthy Balance Sheet?

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 note that DaTang HuaYin Electric Power CO.,LTD (SHSE:600744) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for DaTang HuaYin Electric PowerLTD

What Is DaTang HuaYin Electric PowerLTD's Debt?

As you can see below, at the end of March 2024, DaTang HuaYin Electric PowerLTD had CN¥19.6b of debt, up from CN¥16.5b a year ago. Click the image for more detail. However, it does have CN¥955.9m in cash offsetting this, leading to net debt of about CN¥18.6b.

How Strong Is DaTang HuaYin Electric PowerLTD's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DaTang HuaYin Electric PowerLTD had liabilities of CN¥8.06b due within 12 months and liabilities of CN¥14.3b due beyond that. Offsetting this, it had CN¥955.9m in cash and CN¥1.99b in receivables that were due within 12 months. So it has liabilities totalling CN¥19.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥6.87b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, DaTang HuaYin Electric PowerLTD would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 13.1 hit our confidence in DaTang HuaYin Electric PowerLTD like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for DaTang HuaYin Electric PowerLTD is that it turned last year's EBIT loss into a gain of CN¥340m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is DaTang HuaYin Electric PowerLTD'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, 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, DaTang HuaYin Electric PowerLTD burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, DaTang HuaYin Electric PowerLTD's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. Considering all the factors previously mentioned, we think that DaTang HuaYin Electric PowerLTD really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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 instance, we've identified 3 warning signs for DaTang HuaYin Electric PowerLTD (2 are a bit unpleasant) you should be aware of.

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.

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