Health Check: How Prudently Does China Dredging Environment Protection Holdings (HKG:871) Use Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that China Dredging Environment Protection Holdings Limited (HKG:871) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for China Dredging Environment Protection Holdings

What Is China Dredging Environment Protection Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that China Dredging Environment Protection Holdings had CN¥543.6m of debt in June 2022, down from CN¥603.8m, one year before. However, it does have CN¥35.9m in cash offsetting this, leading to net debt of about CN¥507.8m.

A Look At China Dredging Environment Protection Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that China Dredging Environment Protection Holdings had liabilities of CN¥784.4m due within 12 months and liabilities of CN¥262.6m due beyond that. Offsetting this, it had CN¥35.9m in cash and CN¥554.5m in receivables that were due within 12 months. So its liabilities total CN¥456.6m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥91.5m 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. After all, China Dredging Environment Protection Holdings would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is China Dredging Environment Protection Holdings'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.

In the last year China Dredging Environment Protection Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 32%, to CN¥413m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though China Dredging Environment Protection Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at CN¥8.6m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost CN¥163m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. 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. We've identified 3 warning signs with China Dredging Environment Protection Holdings (at least 1 which is significant) , 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.