Here's Why Canvest Environmental Protection Group (HKG:1381) Is Weighed Down By Its Debt Load

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Canvest Environmental Protection Group Company Limited (HKG:1381) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Canvest Environmental Protection Group

What Is Canvest Environmental Protection Group's Debt?

The chart below, which you can click on for greater detail, shows that Canvest Environmental Protection Group had HK$13.7b in debt in June 2023; about the same as the year before. However, it also had HK$1.86b in cash, and so its net debt is HK$11.9b.

A Look At Canvest Environmental Protection Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Canvest Environmental Protection Group had liabilities of HK$4.00b due within 12 months and liabilities of HK$13.2b due beyond that. Offsetting this, it had HK$1.86b in cash and HK$2.73b in receivables that were due within 12 months. So it has liabilities totalling HK$12.7b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$10.6b, we think shareholders really should watch Canvest Environmental Protection 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Canvest Environmental Protection Group's debt is 4.2 times its EBITDA, and its EBIT cover its interest expense 3.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Canvest Environmental Protection Group's EBIT was pretty flat over the last year, which isn't ideal given the 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 Canvest Environmental Protection 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Canvest Environmental Protection Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Canvest Environmental Protection Group's conversion of EBIT to free cash flow was disappointing. But at least its EBIT growth rate is not so bad. We're quite clear that we consider Canvest Environmental Protection Group to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. To that end, you should be aware of the 1 warning sign we've spotted with Canvest Environmental Protection Group .

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.