Is China Dredging Environment Protection Holdings (HKG:871) Using Too Much 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies China Dredging Environment Protection Holdings Limited (HKG:871) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for China Dredging Environment Protection Holdings

What Is China Dredging Environment Protection Holdings's Debt?

As you can see below, at the end of December 2020, China Dredging Environment Protection Holdings had CN¥770.3m of debt, up from CN¥687.1m a year ago. Click the image for more detail. However, it does have CN¥46.3m in cash offsetting this, leading to net debt of about CN¥724.0m.

How Healthy Is China Dredging Environment Protection Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Dredging Environment Protection Holdings had liabilities of CN¥1.17b due within 12 months and liabilities of CN¥201.0m due beyond that. Offsetting this, it had CN¥46.3m in cash and CN¥535.5m in receivables that were due within 12 months. So its liabilities total CN¥788.6m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥196.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Dredging Environment Protection Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Dredging Environment Protection Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China Dredging Environment Protection Holdings had a loss before interest and tax, and actually shrunk its revenue by 35%, to CN¥286m. That makes us nervous, to say the least.

Caveat Emptor

Not only did China Dredging Environment Protection Holdings'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 CN¥275m at the EBIT level. 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. But we think that is unlikely since it is low on liquid assets, and made a loss of CN¥508m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for China Dredging Environment Protection Holdings (2 make us uncomfortable!) that you should be aware of before investing here.

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. 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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