These 4 Measures Indicate That CECEP Wind-power CorporationLtd (SHSE:601016) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies CECEP Wind-power Corporation Co.,Ltd. (SHSE:601016) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for CECEP Wind-power CorporationLtd

What Is CECEP Wind-power CorporationLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 CECEP Wind-power CorporationLtd had debt of CN¥22.6b, up from CN¥21.5b in one year. On the flip side, it has CN¥2.51b in cash leading to net debt of about CN¥20.1b.

How Strong Is CECEP Wind-power CorporationLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CECEP Wind-power CorporationLtd had liabilities of CN¥4.83b due within 12 months and liabilities of CN¥20.8b due beyond that. On the other hand, it had cash of CN¥2.51b and CN¥7.42b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥15.7b.

This is a mountain of leverage relative to its market capitalization of CN¥20.9b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). 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).

CECEP Wind-power CorporationLtd's debt is 4.6 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. More concerning, CECEP Wind-power CorporationLtd saw its EBIT drop by 7.4% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine CECEP Wind-power CorporationLtd'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, CECEP Wind-power CorporationLtd recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say CECEP Wind-power CorporationLtd's net debt to EBITDA was disappointing. But at least its conversion of EBIT to free cash flow is not so bad. Overall, we think it's fair to say that CECEP Wind-power CorporationLtd has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for CECEP Wind-power CorporationLtd (1 shouldn't be ignored!) 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.