Is China Water Industry Group (HKG:1129) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, China Water Industry Group Limited (HKG:1129) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Water Industry Group

What Is China Water Industry Group's Debt?

As you can see below, at the end of December 2023, China Water Industry Group had HK$632.1m of debt, up from HK$485.4m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$241.4m, its net debt is less, at about HK$390.7m.

A Look At China Water Industry Group's Liabilities

According to the last reported balance sheet, China Water Industry Group had liabilities of HK$1.07b due within 12 months, and liabilities of HK$659.2m due beyond 12 months. Offsetting these obligations, it had cash of HK$241.4m as well as receivables valued at HK$939.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$548.7m.

Given this deficit is actually higher than the company's market capitalization of HK$416.7m, we think shareholders really should watch China Water Industry Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Water Industry Group'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 Water Industry Group had a loss before interest and tax, and actually shrunk its revenue by 40%, to HK$734m. That makes us nervous, to say the least.

Caveat Emptor

Not only did China Water Industry Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$113m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$146m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with China Water Industry Group (including 1 which doesn't sit too well with us) .

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.