These 4 Measures Indicate That ENN Energy Holdings (HKG:2688) Is Using Debt Reasonably Well

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. As with many other companies ENN Energy Holdings Limited (HKG:2688) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 ENN Energy Holdings

How Much Debt Does ENN Energy Holdings Carry?

The chart below, which you can click on for greater detail, shows that ENN Energy Holdings had CN¥21.9b in debt in June 2023; about the same as the year before. However, because it has a cash reserve of CN¥11.1b, its net debt is less, at about CN¥10.8b.

A Look At ENN Energy Holdings' Liabilities

According to the last reported balance sheet, ENN Energy Holdings had liabilities of CN¥37.3b due within 12 months, and liabilities of CN¥21.4b due beyond 12 months. Offsetting these obligations, it had cash of CN¥11.1b as well as receivables valued at CN¥9.95b due within 12 months. So it has liabilities totalling CN¥37.7b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since ENN Energy Holdings has a market capitalization of CN¥68.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

ENN Energy Holdings's net debt is only 0.83 times its EBITDA. And its EBIT covers its interest expense a whopping 28.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that ENN Energy Holdings grew its EBIT by 19% last year, making its debt load easier to handle. 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 ENN Energy Holdings'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 we always check how much of that EBIT is translated into free cash flow. In the last three years, ENN Energy Holdings's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

ENN Energy Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. It's also worth noting that ENN Energy Holdings is in the Gas Utilities industry, which is often considered to be quite defensive. All these things considered, it appears that ENN Energy Holdings can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for ENN Energy Holdings you should know about.

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.