These 4 Measures Indicate That Zhongyu Energy Holdings (HKG:3633) Is Using Debt In A Risky Way

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 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. We note that Zhongyu Energy Holdings Limited (HKG:3633) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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When Is Debt A Problem?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Zhongyu Energy Holdings Carry?

As you can see below, at the end of June 2025, Zhongyu Energy Holdings had HK$13.3b of debt, up from HK$12.5b a year ago. Click the image for more detail. However, because it has a cash reserve of HK$2.58b, its net debt is less, at about HK$10.7b.

How Strong Is Zhongyu Energy Holdings' Balance Sheet?

We can see from the most recent balance sheet that Zhongyu Energy Holdings had liabilities of HK$11.3b falling due within a year, and liabilities of HK$6.46b due beyond that. Offsetting this, it had HK$2.58b in cash and HK$2.76b in receivables that were due within 12 months. So it has liabilities totalling HK$12.4b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$8.90b, we think shareholders really should watch Zhongyu Energy Holdings'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.

See our latest analysis for Zhongyu Energy Holdings

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhongyu Energy Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (8.6), and fairly weak interest coverage, since EBIT is just 1.2 times the interest expense. The debt burden here is substantial. Worse, Zhongyu Energy Holdings's EBIT was down 23% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhongyu Energy Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Zhongyu Energy Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Zhongyu Energy Holdings's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its level of total liabilities fails to inspire much confidence. It's also worth noting that Zhongyu Energy Holdings is in the Gas Utilities industry, which is often considered to be quite defensive. Considering all the factors previously mentioned, we think that Zhongyu Energy Holdings really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. We've identified 3 warning signs with Zhongyu Energy Holdings (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.