Is China Southern Power Grid Energy Storage (SHSE:600995) 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.' 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. We can see that China Southern Power Grid Energy Storage Co., Ltd. (SHSE:600995) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Southern Power Grid Energy Storage

How Much Debt Does China Southern Power Grid Energy Storage Carry?

The image below, which you can click on for greater detail, shows that at December 2023 China Southern Power Grid Energy Storage had debt of CN¥14.8b, up from CN¥10.5b in one year. However, it does have CN¥4.03b in cash offsetting this, leading to net debt of about CN¥10.7b.

How Strong Is China Southern Power Grid Energy Storage's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Southern Power Grid Energy Storage had liabilities of CN¥4.40b due within 12 months and liabilities of CN¥15.8b due beyond that. Offsetting these obligations, it had cash of CN¥4.03b as well as receivables valued at CN¥468.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥15.7b.

This deficit isn't so bad because China Southern Power Grid Energy Storage is worth CN¥31.3b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

China Southern Power Grid Energy Storage's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 4.4 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, China Southern Power Grid Energy Storage saw its EBIT tank 40% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Southern Power Grid Energy Storage's ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, China Southern Power Grid Energy Storage 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

To be frank both China Southern Power Grid Energy Storage's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. It's also worth noting that China Southern Power Grid Energy Storage is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, it seems to us that China Southern Power Grid Energy Storage's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - China Southern Power Grid Energy Storage has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.