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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Zhejiang Tengy Environmental Technology Co., Ltd (HKG:1527) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

See our latest analysis for Zhejiang Tengy Environmental Technology

How Much Debt Does Zhejiang Tengy Environmental Technology Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Zhejiang Tengy Environmental Technology had debt of CN¥89.5m, up from CN¥85.0m in one year. But it also has CN¥535.3m in cash to offset that, meaning it has CN¥445.8m net cash.

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¥949.9m due within 12 months and no liabilities due beyond that. On the other hand, it had cash of CN¥535.3m and CN¥608.7m worth of receivables due within a year. So it can boast CN¥194.1m more liquid assets than total liabilities.

This excess liquidity is a great indication that Zhejiang Tengy Environmental Technology's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Zhejiang Tengy Environmental Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Zhejiang Tengy Environmental Technology made a loss at the EBIT level, last year, it was also good to see that it generated CN¥90m in EBIT over the last twelve months. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhejiang Tengy Environmental Technology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Zhejiang Tengy Environmental Technology actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Tengy Environmental Technology has CN¥445.8m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥269m, being 300% of its EBIT. So we don't think Zhejiang Tengy Environmental Technology's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Tengy Environmental Technology you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.