Here's Why Huaibei GreenGold Industry Investment (HKG:2450) Is Weighed Down By Its Debt Load

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 note that Huaibei GreenGold Industry Investment Co., Ltd. (HKG:2450) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Huaibei GreenGold Industry Investment

What Is Huaibei GreenGold Industry Investment's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Huaibei GreenGold Industry Investment had CN¥1.36b of debt, an increase on CN¥835.4m, over one year. On the flip side, it has CN¥566.7m in cash leading to net debt of about CN¥793.3m.

A Look At Huaibei GreenGold Industry Investment's Liabilities

We can see from the most recent balance sheet that Huaibei GreenGold Industry Investment had liabilities of CN¥467.1m falling due within a year, and liabilities of CN¥1.46b due beyond that. Offsetting this, it had CN¥566.7m in cash and CN¥52.2m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.31b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥252.2m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Huaibei GreenGold Industry Investment would probably need a major re-capitalization if its creditors were to demand repayment.

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).

Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in Huaibei GreenGold Industry Investment like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Huaibei GreenGold Industry Investment saw its EBIT tank 52% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Huaibei GreenGold Industry Investment's earnings that will influence how the balance sheet holds up in the future. 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 that EBIT is backed by free cash flow. Considering the last three years, Huaibei GreenGold Industry Investment actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Huaibei GreenGold Industry Investment's EBIT growth rate 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. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Huaibei GreenGold Industry Investment is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. Be aware that Huaibei GreenGold Industry Investment is showing 4 warning signs in our investment analysis , and 2 of those are concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.