Here's Why China Ruifeng Renewable Energy Holdings (HKG:527) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that China Ruifeng Renewable Energy Holdings Limited (HKG:527) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Ruifeng Renewable Energy Holdings

How Much Debt Does China Ruifeng Renewable Energy Holdings Carry?

As you can see below, China Ruifeng Renewable Energy Holdings had CN¥1.72b of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥451.2m in cash offsetting this, leading to net debt of about CN¥1.27b.

A Look At China Ruifeng Renewable Energy Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that China Ruifeng Renewable Energy Holdings had liabilities of CN¥479.8m due within 12 months and liabilities of CN¥1.41b due beyond that. Offsetting this, it had CN¥451.2m in cash and CN¥318.4m in receivables that were due within 12 months. So its liabilities total CN¥1.12b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥84.9m 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. At the end of the day, China Ruifeng Renewable Energy Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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

China Ruifeng Renewable Energy Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (6.9), and fairly weak interest coverage, since EBIT is just 0.19 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for China Ruifeng Renewable Energy Holdings is that it turned last year's EBIT loss into a gain of CN¥28m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is China Ruifeng Renewable Energy Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Considering the last year, China Ruifeng Renewable 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, China Ruifeng Renewable Energy Holdings's interest cover 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. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like China Ruifeng Renewable Energy 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Ruifeng Renewable Energy Holdings is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

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. 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.