Datang Environment Industry Group (HKG:1272) Is Making Moderate Use Of 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.' 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 Datang Environment Industry Group Co., Ltd. (HKG:1272) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that 1272 is potentially undervalued!

How Much Debt Does Datang Environment Industry Group Carry?

As you can see below, at the end of June 2022, Datang Environment Industry Group had CN¥5.36b of debt, up from CN¥4.89b a year ago. Click the image for more detail. However, it does have CN¥1.02b in cash offsetting this, leading to net debt of about CN¥4.34b.

How Healthy Is Datang Environment Industry Group's Balance Sheet?

According to the last reported balance sheet, Datang Environment Industry Group had liabilities of CN¥9.62b due within 12 months, and liabilities of CN¥1.59b due beyond 12 months. Offsetting this, it had CN¥1.02b in cash and CN¥8.90b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.28b.

While this might seem like a lot, it is not so bad since Datang Environment Industry Group has a market capitalization of CN¥2.42b, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Datang Environment Industry 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.

In the last year Datang Environment Industry Group had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥5.4b. We would much prefer see growth.

Caveat Emptor

Not only did Datang Environment Industry Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥20m. 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. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥98m. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Datang Environment Industry Group (2 are a bit unpleasant!) 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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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.