China Three Gorges Renewables (Group)Ltd (SHSE:600905) Seems To Be Using A Lot Of Debt

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. Importantly, China Three Gorges Renewables (Group) Co.,Ltd. (SHSE:600905) does carry debt. But is this debt a concern to shareholders?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for China Three Gorges Renewables (Group)Ltd

What Is China Three Gorges Renewables (Group)Ltd's Debt?

As you can see below, at the end of September 2024, China Three Gorges Renewables (Group)Ltd had CN¥176.1b of debt, up from CN¥143.0b a year ago. Click the image for more detail. On the flip side, it has CN¥8.95b in cash leading to net debt of about CN¥167.2b.

A Look At China Three Gorges Renewables (Group)Ltd's Liabilities

We can see from the most recent balance sheet that China Three Gorges Renewables (Group)Ltd had liabilities of CN¥53.0b falling due within a year, and liabilities of CN¥186.0b due beyond that. Offsetting these obligations, it had cash of CN¥8.95b as well as receivables valued at CN¥43.5b due within 12 months. So it has liabilities totalling CN¥186.5b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥122.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, China Three Gorges Renewables (Group)Ltd would likely require a major re-capitalisation if it had to pay its creditors today.

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).

With a net debt to EBITDA ratio of 7.1, it's fair to say China Three Gorges Renewables (Group)Ltd does have a significant amount of debt. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. Fortunately, China Three Gorges Renewables (Group)Ltd grew its EBIT by 6.2% in the last year, slowly shrinking its debt relative to earnings. 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 China Three Gorges Renewables (Group)Ltd 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, 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, China Three Gorges Renewables (Group)Ltd saw substantial negative free cash flow, in total. 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, China Three Gorges Renewables (Group)Ltd'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. But at least it's pretty decent at growing its EBIT; that's encouraging. After considering the datapoints discussed, we think China Three Gorges Renewables (Group)Ltd 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for China Three Gorges Renewables (Group)Ltd (1 doesn't sit too well with us) 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.