Is China Ecotourism Group (HKG:1371) Using Debt Sensibly?

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, China Ecotourism Group Limited (HKG:1371) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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 China Ecotourism Group

What Is China Ecotourism Group's Debt?

The image below, which you can click on for greater detail, shows that China Ecotourism Group had debt of HK$340.1m at the end of June 2021, a reduction from HK$402.2m over a year. However, it also had HK$129.4m in cash, and so its net debt is HK$210.7m.

How Healthy Is China Ecotourism Group's Balance Sheet?

According to the last reported balance sheet, China Ecotourism Group had liabilities of HK$448.3m due within 12 months, and liabilities of HK$41.1m due beyond 12 months. Offsetting this, it had HK$129.4m in cash and HK$10.4m in receivables that were due within 12 months. So it has liabilities totalling HK$349.6m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$296.5m, we think shareholders really should watch China Ecotourism 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. 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's revenue was pretty flat, and it made a negative EBIT. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, China Ecotourism Group had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$140m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of HK$89m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for China Ecotourism Group (of which 3 are significant!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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