Beijing Enterprises Holdings (HKG:392) Seems To Be Using A Lot Of 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Beijing Enterprises Holdings Limited (HKG:392) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Beijing Enterprises Holdings

What Is Beijing Enterprises Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Beijing Enterprises Holdings had debt of HK$81.9b, up from HK$71.8b in one year. However, because it has a cash reserve of HK$33.4b, its net debt is less, at about HK$48.5b.

How Healthy Is Beijing Enterprises Holdings' Balance Sheet?

We can see from the most recent balance sheet that Beijing Enterprises Holdings had liabilities of HK$54.4b falling due within a year, and liabilities of HK$67.6b due beyond that. On the other hand, it had cash of HK$33.4b and HK$6.80b worth of receivables due within a year. So its liabilities total HK$81.8b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$34.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Beijing Enterprises Holdings 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 5.8, it's fair to say Beijing Enterprises Holdings does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 2.6 times, suggesting it can responsibly service its obligations. The good news is that Beijing Enterprises Holdings improved its EBIT by 4.6% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. 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 Holdings 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Beijing Enterprises Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Beijing Enterprises Holdings's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We should also note that Gas Utilities industry companies like Beijing Enterprises Holdings commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Beijing Enterprises Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Beijing Enterprises Holdings (including 1 which doesn't sit too well with us) .

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.