These 4 Measures Indicate That Huadian Power International (HKG:1071) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Huadian Power International Corporation Limited (HKG:1071) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huadian Power International

What Is Huadian Power International's Debt?

The chart below, which you can click on for greater detail, shows that Huadian Power International had CN¥116.6b in debt in September 2023; about the same as the year before. On the flip side, it has CN¥7.37b in cash leading to net debt of about CN¥109.3b.

How Strong Is Huadian Power International's Balance Sheet?

The latest balance sheet data shows that Huadian Power International had liabilities of CN¥54.3b due within a year, and liabilities of CN¥82.4b falling due after that. Offsetting these obligations, it had cash of CN¥7.37b as well as receivables valued at CN¥13.5b due within 12 months. So it has liabilities totalling CN¥115.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥48.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Huadian Power International would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Huadian Power International has a fairly concerning net debt to EBITDA ratio of 10.0 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Notably, Huadian Power International made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥2.3b in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Huadian Power International's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Huadian Power International recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Huadian Power International's net debt to EBITDA 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 on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Huadian Power International has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Huadian Power International (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.