Is CHN Energy Changyuan Electric PowerLtd (SZSE:000966) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, CHN Energy Changyuan Electric Power Co.,Ltd. (SZSE:000966) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for CHN Energy Changyuan Electric PowerLtd

What Is CHN Energy Changyuan Electric PowerLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 CHN Energy Changyuan Electric PowerLtd had CN¥22.8b of debt, an increase on CN¥17.9b, over one year. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is CHN Energy Changyuan Electric PowerLtd's Balance Sheet?

We can see from the most recent balance sheet that CHN Energy Changyuan Electric PowerLtd had liabilities of CN¥10.6b falling due within a year, and liabilities of CN¥16.1b due beyond that. Offsetting these obligations, it had cash of CN¥299.5m as well as receivables valued at CN¥1.78b due within 12 months. So its liabilities total CN¥24.6b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥11.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, CHN Energy Changyuan Electric PowerLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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

CHN Energy Changyuan Electric PowerLtd has a rather high debt to EBITDA ratio of 9.0 which suggests a meaningful debt load. However, its interest coverage of 2.5 is reasonably strong, which is a good sign. Looking on the bright side, CHN Energy Changyuan Electric PowerLtd boosted its EBIT by a silky 48% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 CHN Energy Changyuan Electric PowerLtd'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, CHN Energy Changyuan Electric PowerLtd 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 CHN Energy Changyuan Electric PowerLtd's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider CHN Energy Changyuan Electric PowerLtd to be really rather risky, as a result of its balance sheet health. 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. 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. To that end, you should learn about the 2 warning signs we've spotted with CHN Energy Changyuan Electric PowerLtd (including 1 which is concerning) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.