We Think China Resources Gas Group (HKG:1193) Can Stay On Top Of Its Debt

By
Simply Wall St
Published
May 08, 2022
SEHK:1193
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, China Resources Gas Group Limited (HKG:1193) does carry debt. But the real question is whether this debt is making the company risky.

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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Resources Gas Group

What Is China Resources Gas Group's Debt?

The chart below, which you can click on for greater detail, shows that China Resources Gas Group had HK$11.6b in debt in December 2021; about the same as the year before. However, it does have HK$8.21b in cash offsetting this, leading to net debt of about HK$3.39b.

debt-equity-history-analysis
SEHK:1193 Debt to Equity History May 8th 2022

A Look At China Resources Gas Group's Liabilities

According to the last reported balance sheet, China Resources Gas Group had liabilities of HK$48.7b due within 12 months, and liabilities of HK$3.40b due beyond 12 months. Offsetting these obligations, it had cash of HK$8.21b as well as receivables valued at HK$12.5b due within 12 months. So its liabilities total HK$31.4b more than the combination of its cash and short-term receivables.

China Resources Gas Group has a market capitalization of HK$66.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

China Resources Gas Group has a low net debt to EBITDA ratio of only 0.30. And its EBIT covers its interest expense a whopping 173 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that China Resources Gas Group has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. 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 China Resources Gas Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, China Resources Gas Group produced sturdy free cash flow equating to 50% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that China Resources Gas Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. We would also note that Gas Utilities industry companies like China Resources Gas Group commonly do use debt without problems. Taking all this data into account, it seems to us that China Resources Gas Group takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with China Resources Gas Group , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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