Health Check: How Prudently Does China Environmental Resources Group (HKG:1130) Use Debt?

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. We note that China Environmental Resources Group Limited (HKG:1130) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Environmental Resources Group

What Is China Environmental Resources Group's Net Debt?

As you can see below, at the end of December 2021, China Environmental Resources Group had HK$69.7m of debt, up from HK$32.2m a year ago. Click the image for more detail. On the flip side, it has HK$7.64m in cash leading to net debt of about HK$62.1m.

A Look At China Environmental Resources Group's Liabilities

We can see from the most recent balance sheet that China Environmental Resources Group had liabilities of HK$113.4m falling due within a year, and liabilities of HK$139.1m due beyond that. Offsetting these obligations, it had cash of HK$7.64m as well as receivables valued at HK$40.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$204.7m.

The deficiency here weighs heavily on the HK$97.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, China Environmental Resources Group would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Environmental Resources Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, China Environmental Resources Group reported revenue of HK$83m, which is a gain of 19%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months China Environmental Resources Group produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$20m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of HK$14m over the last twelve months. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. 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 China Environmental Resources Group (including 1 which makes us a bit uncomfortable) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.