Beijing Enterprises Holdings (HKG:392) Use Of Debt Could Be Considered Risky

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Beijing Enterprises Holdings Limited (HKG:392) does carry 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Beijing Enterprises Holdings

What Is Beijing Enterprises Holdings's Net Debt?

As you can see below, at the end of December 2020, Beijing Enterprises Holdings had HK$68.6b of debt, up from HK$63.8b a year ago. Click the image for more detail. On the flip side, it has HK$29.4b in cash leading to net debt of about HK$39.3b.

How Healthy Is Beijing Enterprises Holdings' Balance Sheet?

According to the last reported balance sheet, Beijing Enterprises Holdings had liabilities of HK$50.5b due within 12 months, and liabilities of HK$56.9b due beyond 12 months. Offsetting this, it had HK$29.4b in cash and HK$7.51b in receivables that were due within 12 months. So its liabilities total HK$70.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$34.6b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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.

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 1.8 times and a disturbingly high net debt to EBITDA ratio of 5.2 hit our confidence in Beijing Enterprises Holdings like a one-two punch to the gut. The debt burden here is substantial. Another concern for investors might be that Beijing Enterprises Holdings's EBIT fell 11% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Beijing Enterprises Holdings's ability to maintain a healthy balance sheet going forward. 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Beijing Enterprises Holdings's free cash flow amounted to 23% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Beijing Enterprises Holdings's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its EBIT growth rate fails to inspire much confidence. 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Beijing Enterprises Holdings (1 is potentially serious!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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