Is China Environmental Technology and Bioenergy Holdings (HKG:1237) Using Debt In A Risky Way?

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 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. We can see that China Environmental Technology and Bioenergy Holdings Limited (HKG:1237) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Environmental Technology and Bioenergy Holdings

How Much Debt Does China Environmental Technology and Bioenergy Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2021 China Environmental Technology and Bioenergy Holdings had debt of CN¥60.9m, up from CN¥8.99m in one year. However, it does have CN¥182.4m in cash offsetting this, leading to net cash of CN¥121.5m.

A Look At China Environmental Technology and Bioenergy Holdings' Liabilities

We can see from the most recent balance sheet that China Environmental Technology and Bioenergy Holdings had liabilities of CN¥111.4m falling due within a year, and liabilities of CN¥7.45m due beyond that. On the other hand, it had cash of CN¥182.4m and CN¥83.0m worth of receivables due within a year. So it can boast CN¥146.5m more liquid assets than total liabilities.

This luscious liquidity implies that China Environmental Technology and Bioenergy Holdings' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that China Environmental Technology and Bioenergy Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Environmental Technology and Bioenergy Holdings 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.

In the last year China Environmental Technology and Bioenergy Holdings had a loss before interest and tax, and actually shrunk its revenue by 23%, to CN¥458m. That makes us nervous, to say the least.

So How Risky Is China Environmental Technology and Bioenergy Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months China Environmental Technology and Bioenergy Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥21m and booked a CN¥61m accounting loss. With only CN¥121.5m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with China Environmental Technology and Bioenergy Holdings (including 1 which is significant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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