Here's Why China Datang Corporation Renewable Power (HKG:1798) Is Weighed Down By Its Debt Load

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 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, China Datang Corporation Renewable Power Co., Limited (HKG:1798) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for China Datang Corporation Renewable Power

What Is China Datang Corporation Renewable Power's Net Debt?

The chart below, which you can click on for greater detail, shows that China Datang Corporation Renewable Power had CN¥50.1b in debt in June 2022; about the same as the year before. However, it also had CN¥4.93b in cash, and so its net debt is CN¥45.2b.

How Healthy Is China Datang Corporation Renewable Power's Balance Sheet?

We can see from the most recent balance sheet that China Datang Corporation Renewable Power had liabilities of CN¥15.9b falling due within a year, and liabilities of CN¥45.3b due beyond that. On the other hand, it had cash of CN¥4.93b and CN¥13.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥42.5b.

This deficit casts a shadow over the CN¥14.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Datang Corporation Renewable Power would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about China Datang Corporation Renewable Power's net debt to EBITDA ratio of 4.8, we think its super-low interest cover of 2.3 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. More concerning, China Datang Corporation Renewable Power saw its EBIT drop by 2.3% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Datang Corporation Renewable Power'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, China Datang Corporation Renewable Power created free cash flow amounting to 8.5% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over China Datang Corporation Renewable Power's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think China Datang Corporation Renewable Power has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China Datang Corporation Renewable Power you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.