Is Zhejiang Tengy Environmental Technology (HKG:1527) A Risky Investment?

Simply Wall St
September 05, 2021
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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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Zhejiang Tengy Environmental Technology Co., Ltd (HKG:1527) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Zhejiang Tengy Environmental Technology

What Is Zhejiang Tengy Environmental Technology's Debt?

The chart below, which you can click on for greater detail, shows that Zhejiang Tengy Environmental Technology had CN¥106.7m in debt in June 2021; about the same as the year before. However, it does have CN¥16.4m in cash offsetting this, leading to net debt of about CN¥90.3m.

SEHK:1527 Debt to Equity History September 6th 2021

How Strong Is Zhejiang Tengy Environmental Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhejiang Tengy Environmental Technology had liabilities of CN¥825.6m due within 12 months and no liabilities due beyond that. On the other hand, it had cash of CN¥16.4m and CN¥830.8m worth of receivables due within a year. So it can boast CN¥21.6m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Tengy Environmental Technology is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhejiang Tengy Environmental Technology'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.

In the last year Zhejiang Tengy Environmental Technology had a loss before interest and tax, and actually shrunk its revenue by 15%, to CN¥534m. That's not what we would hope to see.

Caveat Emptor

While Zhejiang Tengy Environmental Technology's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥1.1m. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. And on top of that, it booked free cash flow of CN¥129m and profit of CN¥3.6m over the last year. This one is a bit too risky for our liking. 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. For example Zhejiang Tengy Environmental Technology has 3 warning signs (and 1 which can't be ignored) we think you should know about.

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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