Henan Yuneng HoldingsLtd (SZSE:001896) Has No Shortage 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. We can see that Henan Yuneng Holdings Co.,Ltd. (SZSE:001896) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Henan Yuneng HoldingsLtd

What Is Henan Yuneng HoldingsLtd's Debt?

As you can see below, at the end of June 2024, Henan Yuneng HoldingsLtd had CN¥23.0b of debt, up from CN¥19.7b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥2.03b, its net debt is less, at about CN¥20.9b.

How Strong Is Henan Yuneng HoldingsLtd's Balance Sheet?

We can see from the most recent balance sheet that Henan Yuneng HoldingsLtd had liabilities of CN¥12.3b falling due within a year, and liabilities of CN¥16.2b due beyond that. Offsetting these obligations, it had cash of CN¥2.03b as well as receivables valued at CN¥2.23b due within 12 months. So it has liabilities totalling CN¥24.3b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥6.32b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Henan Yuneng HoldingsLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.88 times and a disturbingly high net debt to EBITDA ratio of 10.4 hit our confidence in Henan Yuneng HoldingsLtd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Henan Yuneng HoldingsLtd is that it turned last year's EBIT loss into a gain of CN¥655m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Henan Yuneng HoldingsLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Henan Yuneng HoldingsLtd burned a lot of cash. 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, Henan Yuneng HoldingsLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. We should also note that Electric Utilities industry companies like Henan Yuneng HoldingsLtd commonly do use debt without problems. After considering the datapoints discussed, we think Henan Yuneng HoldingsLtd has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Henan Yuneng HoldingsLtd 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.