Beijing Enterprises Clean Energy Group (HKG:1250) Has No Shortage Of Debt

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.' 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. As with many other companies Beijing Enterprises Clean Energy Group Limited (HKG:1250) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Beijing Enterprises Clean Energy Group

What Is Beijing Enterprises Clean Energy Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Beijing Enterprises Clean Energy Group had HK$27.6b of debt, an increase on HK$23.7b, over one year. On the flip side, it has HK$1.72b in cash leading to net debt of about HK$25.9b.

A Look At Beijing Enterprises Clean Energy Group's Liabilities

According to the last reported balance sheet, Beijing Enterprises Clean Energy Group had liabilities of HK$18.7b due within 12 months, and liabilities of HK$24.1b due beyond 12 months. Offsetting these obligations, it had cash of HK$1.72b as well as receivables valued at HK$12.3b due within 12 months. So it has liabilities totalling HK$28.8b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$9.32b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. 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.

Beijing Enterprises Clean Energy Group shareholders face the double whammy of a high net debt to EBITDA ratio (9.8), and fairly weak interest coverage, since EBIT is just 0.87 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Beijing Enterprises Clean Energy Group's EBIT was down 40% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Beijing Enterprises Clean Energy Group will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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.

Our View

To be frank both Beijing Enterprises Clean Energy Group's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Beijing Enterprises Clean Energy Group is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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 Beijing Enterprises Clean Energy Group (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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.

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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.