Is Dynagreen Environmental Protection Group (HKG:1330) A Risky Investment?

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.' 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. Importantly, Dynagreen Environmental Protection Group Co., Ltd. (HKG:1330) does carry debt. But is this debt a concern to shareholders?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dynagreen Environmental Protection Group

How Much Debt Does Dynagreen Environmental Protection Group Carry?

As you can see below, Dynagreen Environmental Protection Group had CN¥11.8b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥1.06b in cash offsetting this, leading to net debt of about CN¥10.7b.

How Strong Is Dynagreen Environmental Protection Group's Balance Sheet?

According to the last reported balance sheet, Dynagreen Environmental Protection Group had liabilities of CN¥2.79b due within 12 months, and liabilities of CN¥11.0b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.06b as well as receivables valued at CN¥2.88b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.85b.

Given this deficit is actually higher than the company's market capitalization of CN¥7.85b, we think shareholders really should watch Dynagreen Environmental Protection Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 5.9, it's fair to say Dynagreen Environmental Protection Group does have a significant amount of debt. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. Notably, Dynagreen Environmental Protection Group's EBIT was pretty flat over the last year, which isn't ideal given the debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Dynagreen Environmental Protection Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Dynagreen Environmental Protection Group recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Dynagreen Environmental Protection Group's net debt to EBITDA was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Dynagreen Environmental Protection Group's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Be aware that Dynagreen Environmental Protection Group is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.