Is ZONBONG LANDSCAPE Environmental (HKG:1855) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, ZONBONG LANDSCAPE Environmental Limited (HKG:1855) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ZONBONG LANDSCAPE Environmental

How Much Debt Does ZONBONG LANDSCAPE Environmental Carry?

The image below, which you can click on for greater detail, shows that at December 2023 ZONBONG LANDSCAPE Environmental had debt of CN¥806.2m, up from CN¥663.2m in one year. However, it also had CN¥210.4m in cash, and so its net debt is CN¥595.8m.

A Look At ZONBONG LANDSCAPE Environmental's Liabilities

Zooming in on the latest balance sheet data, we can see that ZONBONG LANDSCAPE Environmental had liabilities of CN¥2.99b due within 12 months and liabilities of CN¥91.7m due beyond that. Offsetting these obligations, it had cash of CN¥210.4m as well as receivables valued at CN¥2.88b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to ZONBONG LANDSCAPE Environmental's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥6.52b company is short on cash, but still worth keeping an eye on the balance sheet.

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). 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).

ZONBONG LANDSCAPE Environmental's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 3.7 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. However, the silver lining was that ZONBONG LANDSCAPE Environmental achieved a positive EBIT of CN¥241m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since ZONBONG LANDSCAPE Environmental 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, ZONBONG LANDSCAPE Environmental actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

ZONBONG LANDSCAPE Environmental's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its level of total liabilities is relatively strong. We think that ZONBONG LANDSCAPE Environmental's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example - ZONBONG LANDSCAPE Environmental has 2 warning signs we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.