Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Beijing Enterprises Clean Energy Group Limited (HKG:1250) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Beijing Enterprises Clean Energy Group's Net Debt?
As you can see below, at the end of June 2021, Beijing Enterprises Clean Energy Group had HK$25.7b of debt, up from HK$14.4b a year ago. Click the image for more detail. However, it does have HK$2.37b in cash offsetting this, leading to net debt of about HK$23.3b.
A Look At Beijing Enterprises Clean Energy Group's Liabilities
The latest balance sheet data shows that Beijing Enterprises Clean Energy Group had liabilities of HK$18.4b due within a year, and liabilities of HK$26.8b falling due after that. Offsetting this, it had HK$2.37b in cash and HK$12.6b in receivables that were due within 12 months. So its liabilities total HK$30.3b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the HK$6.29b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Beijing Enterprises Clean Energy Group would probably need a major re-capitalization if its creditors were to demand repayment.
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.
Weak interest cover of 1.8 times and a disturbingly high net debt to EBITDA ratio of 6.9 hit our confidence in Beijing Enterprises Clean Energy Group like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. On the other hand, Beijing Enterprises Clean Energy Group grew its EBIT by 26% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Beijing Enterprises Clean Energy Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Beijing Enterprises Clean Energy Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Beijing Enterprises Clean Energy Group's conversion of EBIT to free cash flow 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 at least it's pretty decent at growing its EBIT; that's encouraging. After considering the datapoints discussed, we think Beijing Enterprises Clean Energy Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Beijing Enterprises Clean Energy Group you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.
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