Is Beijing Enterprises Water Group (HKG:371) Using Too Much 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 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. We note that Beijing Enterprises Water Group Limited (HKG:371) does have debt on its balance sheet. But is this debt a concern to shareholders?

Our free stock report includes 2 warning signs investors should be aware of before investing in Beijing Enterprises Water Group. Read for free now.

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Beijing Enterprises Water Group's Net Debt?

The chart below, which you can click on for greater detail, shows that Beijing Enterprises Water Group had CN¥75.5b in debt in December 2024; about the same as the year before. However, because it has a cash reserve of CN¥9.01b, its net debt is less, at about CN¥66.5b.

A Look At Beijing Enterprises Water Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Beijing Enterprises Water Group had liabilities of CN¥43.3b due within 12 months and liabilities of CN¥67.3b due beyond that. Offsetting these obligations, it had cash of CN¥9.01b as well as receivables valued at CN¥24.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥77.6b.

This deficit casts a shadow over the CN¥22.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Beijing Enterprises Water Group would likely require a major re-capitalisation if it had to pay its creditors today.

Check out our latest analysis for Beijing Enterprises Water Group

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

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 9.6 hit our confidence in Beijing Enterprises Water Group like a one-two punch to the gut. The debt burden here is substantial. Even more troubling is the fact that Beijing Enterprises Water Group actually let its EBIT decrease by 5.2% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. 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 Beijing Enterprises Water 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Beijing Enterprises Water Group reported free cash flow worth 12% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Beijing Enterprises Water Group's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. It's also worth noting that Beijing Enterprises Water Group is in the Water Utilities industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like Beijing Enterprises Water Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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 learn about the 2 warning signs we've spotted with Beijing Enterprises Water Group (including 1 which is a bit concerning) .

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.