Beijing Enterprises Environment Group (HKG:154) Has No Shortage Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Beijing Enterprises Environment Group Limited (HKG:154) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Beijing Enterprises Environment Group

What Is Beijing Enterprises Environment Group's Net Debt?

The image below, which you can click on for greater detail, shows that Beijing Enterprises Environment Group had debt of CN¥4.49b at the end of June 2024, a reduction from CN¥5.36b over a year. However, because it has a cash reserve of CN¥1.17b, its net debt is less, at about CN¥3.32b.

How Healthy Is Beijing Enterprises Environment Group's Balance Sheet?

The latest balance sheet data shows that Beijing Enterprises Environment Group had liabilities of CN¥3.77b due within a year, and liabilities of CN¥2.26b falling due after that. Offsetting these obligations, it had cash of CN¥1.17b as well as receivables valued at CN¥977.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.88b.

This deficit casts a shadow over the CN¥658.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Beijing Enterprises Environment Group would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 5.3, it's fair to say Beijing Enterprises Environment Group does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 3.5 times, suggesting it can responsibly service its obligations. Worse, Beijing Enterprises Environment Group's EBIT was down 27% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Beijing Enterprises Environment Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Beijing Enterprises Environment Group reported free cash flow worth 3.9% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Beijing Enterprises Environment Group's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Considering all the factors previously mentioned, we think that Beijing Enterprises Environment Group really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. Be aware that Beijing Enterprises Environment Group is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.