Here's Why Beijing Enterprises Holdings (HKG:392) Is Weighed Down By Its Debt Load

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. We can see that Beijing Enterprises Holdings Limited (HKG:392) does use debt in its business. But is this debt a concern to shareholders?

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 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.

See our latest analysis for Beijing Enterprises Holdings

What Is Beijing Enterprises Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Beijing Enterprises Holdings had debt of CN¥82.3b, up from CN¥75.8b in one year. However, it does have CN¥34.9b in cash offsetting this, leading to net debt of about CN¥47.4b.

How Healthy Is Beijing Enterprises Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Beijing Enterprises Holdings had liabilities of CN¥69.9b due within 12 months and liabilities of CN¥50.3b due beyond that. On the other hand, it had cash of CN¥34.9b and CN¥5.77b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥79.6b.

This deficit casts a shadow over the CN¥27.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Beijing Enterprises Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Weak interest cover of 0.68 times and a disturbingly high net debt to EBITDA ratio of 9.0 hit our confidence in Beijing Enterprises Holdings like a one-two punch to the gut. The debt burden here is substantial. Worse, Beijing Enterprises Holdings's EBIT was down 67% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding 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

On the face of it, Beijing Enterprises Holdings's EBIT growth rate 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 furthermore, its interest cover also fails to instill confidence. We should also note that Gas Utilities industry companies like Beijing Enterprises Holdings commonly do use debt without problems. Considering everything we've mentioned above, it's fair to say that Beijing Enterprises Holdings is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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 Beijing Enterprises Holdings has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.