These 4 Measures Indicate That China Shuifa Singyes Energy Holdings (HKG:750) Is Using Debt Extensively

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 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 can see that China Shuifa Singyes Energy Holdings Limited (HKG:750) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Shuifa Singyes Energy Holdings

What Is China Shuifa Singyes Energy Holdings's Debt?

The chart below, which you can click on for greater detail, shows that China Shuifa Singyes Energy Holdings had CN¥5.79b in debt in December 2020; about the same as the year before. However, it does have CN¥999.6m in cash offsetting this, leading to net debt of about CN¥4.80b.

How Healthy Is China Shuifa Singyes Energy Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Shuifa Singyes Energy Holdings had liabilities of CN¥5.45b due within 12 months and liabilities of CN¥3.40b due beyond that. Offsetting this, it had CN¥999.6m in cash and CN¥7.05b in receivables that were due within 12 months. So it has liabilities totalling CN¥793.8m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since China Shuifa Singyes Energy Holdings has a market capitalization of CN¥2.45b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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 0.32 times and a disturbingly high net debt to EBITDA ratio of 15.6 hit our confidence in China Shuifa Singyes Energy Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that China Shuifa Singyes Energy Holdings achieved a positive EBIT of CN¥111m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Shuifa Singyes Energy Holdings will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, China Shuifa Singyes Energy Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both China Shuifa Singyes Energy Holdings's net debt to EBITDA and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Overall, we think it's fair to say that China Shuifa Singyes Energy Holdings has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for China Shuifa Singyes Energy Holdings (2 are significant!) that you should be aware of before investing here.

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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