Would China Environmental Resources Group (HKG:1130) Be Better Off With Less 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China Environmental Resources Group Limited (HKG:1130) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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

See our latest analysis for China Environmental Resources Group

How Much Debt Does China Environmental Resources Group Carry?

The chart below, which you can click on for greater detail, shows that China Environmental Resources Group had HK$32.2m in debt in December 2020; about the same as the year before. On the flip side, it has HK$9.44m in cash leading to net debt of about HK$22.8m.

How Strong Is China Environmental Resources Group's Balance Sheet?

We can see from the most recent balance sheet that China Environmental Resources Group had liabilities of HK$82.4m falling due within a year, and liabilities of HK$120.6m due beyond that. Offsetting these obligations, it had cash of HK$9.44m as well as receivables valued at HK$75.2m due within 12 months. So it has liabilities totalling HK$118.4m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of HK$156.8m, so it does suggest shareholders should keep an eye on China Environmental Resources Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. 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 made a loss at the EBIT level, and saw its revenue drop to HK$70m, which is a fall of 27%. To be frank that doesn't bode well.

Caveat Emptor

While China Environmental Resources Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$22m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of HK$46m into a profit. In the meantime, we consider the stock very risky. 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 instance, we've identified 2 warning signs for China Environmental Resources Group that you should be aware of.

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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