We Think CECEP Wind-power CorporationLtd (SHSE:601016) Is Taking Some Risk With Its 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.' 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. We note that CECEP Wind-power Corporation Co.,Ltd. (SHSE:601016) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt 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. However, it also had CN¥2.51b in cash, and so its net debt is CN¥20.1b.

A Look At CECEP Wind-power CorporationLtd's Liabilities

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. Offsetting this, it had CN¥2.51b in cash and CN¥7.42b in receivables that were due within 12 months. So it has liabilities totalling CN¥15.7b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥19.2b, so it does suggest shareholders should keep an eye on CECEP Wind-power CorporationLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CECEP Wind-power CorporationLtd has a debt to EBITDA ratio of 4.6 and its EBIT covered its interest expense 3.7 times. 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 that earnings trend continues the company will face an uphill battle to pay off its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, CECEP Wind-power CorporationLtd's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, CECEP Wind-power CorporationLtd's level of total liabilities left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But at least its conversion of EBIT to free cash flow is not so bad. Looking at the bigger picture, it seems clear to us that CECEP Wind-power CorporationLtd's use of debt is creating risks for the company. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for CECEP Wind-power CorporationLtd (of which 1 is concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.