Is China Resources Gas Group (HKG:1193) A Risky Investment?

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.' 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. We can see that China Resources Gas Group Limited (HKG:1193) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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 China Resources Gas Group

What Is China Resources Gas Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 China Resources Gas Group had debt of HK$17.0b, up from HK$12.4b in one year. However, it does have HK$7.85b in cash offsetting this, leading to net debt of about HK$9.11b.

How Strong Is China Resources Gas Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Resources Gas Group had liabilities of HK$50.0b due within 12 months and liabilities of HK$8.03b due beyond that. Offsetting these obligations, it had cash of HK$7.85b as well as receivables valued at HK$17.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$32.5b.

This deficit isn't so bad because China Resources Gas Group is worth HK$55.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Resources Gas Group's net debt is only 0.84 times its EBITDA. And its EBIT covers its interest expense a whopping 112 times over. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that China Resources Gas Group saw its EBIT decline by 6.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Resources Gas Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, China Resources Gas Group recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis China Resources Gas Group's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to grow its EBIT. It's also worth noting that China Resources Gas Group is in the Gas Utilities industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about China Resources Gas Group's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 1 warning sign for China Resources Gas Group you should be aware of.

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.