Stock Analysis

Datang Environment Industry Group (HKG:1272) Is Making Moderate Use Of Debt

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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Datang Environment Industry Group Co., Ltd. (HKG:1272) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Datang Environment Industry Group

What Is Datang Environment Industry Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Datang Environment Industry Group had CN¥3.91b of debt in September 2022, down from CN¥4.36b, one year before. However, it does have CN¥976.4m in cash offsetting this, leading to net debt of about CN¥2.93b.

SEHK:1272 Debt to Equity History March 15th 2023

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

According to the last reported balance sheet, Datang Environment Industry Group had liabilities of CN¥9.69b due within 12 months, and liabilities of CN¥1.52b due beyond 12 months. Offsetting these obligations, it had cash of CN¥976.4m as well as receivables valued at CN¥9.11b due within 12 months. So it has liabilities totalling CN¥1.13b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Datang Environment Industry Group is worth CN¥2.13b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Datang Environment Industry Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Datang Environment Industry Group made a loss at the EBIT level, and saw its revenue drop to CN¥5.6b, which is a fall of 2.7%. That's not what we would hope to see.

Caveat Emptor

Importantly, Datang Environment Industry Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥159m 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. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥172m into a profit. So in short it's a really risky stock. 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 instance, we've identified 3 warning signs for Datang Environment Industry Group (1 makes us a bit uncomfortable) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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