China Ecotourism Group (HKG:1371) Has Debt But No Earnings; Should You Worry?

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 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 note that China Ecotourism Group Limited (HKG:1371) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Ecotourism Group

How Much Debt Does China Ecotourism Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 China Ecotourism Group had HK$386.4m of debt, an increase on HK$340.1m, over one year. On the flip side, it has HK$53.0m in cash leading to net debt of about HK$333.4m.

How Strong Is China Ecotourism Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Ecotourism Group had liabilities of HK$344.0m due within 12 months and liabilities of HK$200.0m due beyond that. Offsetting these obligations, it had cash of HK$53.0m as well as receivables valued at HK$19.9m due within 12 months. So its liabilities total HK$471.1m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$148.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Ecotourism Group would probably need a major re-capitalization if its creditors were to demand repayment. 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 China Ecotourism 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.

In the last year China Ecotourism Group wasn't profitable at an EBIT level, but managed to grow its revenue by 19%, to HK$136m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months China Ecotourism Group produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$216m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through HK$45m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for China Ecotourism Group (of which 2 don't sit too well with us!) you should know about.

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.