China Environmental Energy Investment (HKG:986) Is Making Moderate Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies China Environmental Energy Investment Limited (HKG:986) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Environmental Energy Investment

What Is China Environmental Energy Investment's Debt?

As you can see below, at the end of September 2023, China Environmental Energy Investment had HK$26.0m of debt, up from HK$17.7m a year ago. Click the image for more detail. However, it does have HK$9.73m in cash offsetting this, leading to net debt of about HK$16.3m.

A Look At China Environmental Energy Investment's Liabilities

We can see from the most recent balance sheet that China Environmental Energy Investment had liabilities of HK$52.2m falling due within a year, and liabilities of HK$10.9m due beyond that. Offsetting these obligations, it had cash of HK$9.73m as well as receivables valued at HK$99.0m due within 12 months. So it can boast HK$45.5m more liquid assets than total liabilities.

This surplus liquidity suggests that China Environmental Energy Investment's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Environmental Energy Investment will need earnings to service that debt. 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.

Over 12 months, China Environmental Energy Investment made a loss at the EBIT level, and saw its revenue drop to HK$64m, which is a fall of 39%. That makes us nervous, to say the least.

Caveat Emptor

Not only did China Environmental Energy Investment's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$12m at the EBIT level. That said, we're impressed with the strong balance sheet liquidity. That should give the business time to grow its cashflow. While the stock is probably a bit risky, there may be an opportunity if the business itself improves, allowing the company to stage a recovery. 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. For example China Environmental Energy Investment has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.

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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.