Here's Why China Suntien Green Energy (HKG:956) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that China Suntien Green Energy Corporation Limited (HKG:956) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Suntien Green Energy

What Is China Suntien Green Energy's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 China Suntien Green Energy had debt of CN¥40.7b, up from CN¥38.9b in one year. However, it does have CN¥4.15b in cash offsetting this, leading to net debt of about CN¥36.5b.

How Healthy Is China Suntien Green Energy's Balance Sheet?

We can see from the most recent balance sheet that China Suntien Green Energy had liabilities of CN¥17.2b falling due within a year, and liabilities of CN¥35.3b due beyond that. Offsetting this, it had CN¥4.15b in cash and CN¥6.71b in receivables that were due within 12 months. So its liabilities total CN¥41.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥23.3b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, China Suntien Green Energy would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

China Suntien Green Energy has a rather high debt to EBITDA ratio of 5.9 which suggests a meaningful debt load. However, its interest coverage of 5.4 is reasonably strong, which is a good sign. The bad news is that China Suntien Green Energy saw its EBIT decline by 10% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Suntien Green Energy's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, China Suntien Green Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, China Suntien Green Energy's conversion of EBIT to free cash flow 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. But at least its interest cover is not so bad. After considering the datapoints discussed, we think China Suntien Green Energy has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with China Suntien Green Energy (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.