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’. 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. As with many other companies Panda Green Energy Group Limited (HKG:686) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Panda Green Energy Group Carry?
As you can see below, at the end of June 2019, Panda Green Energy Group had CN¥19.6b of debt, up from CN¥20.0k a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥394.0m, its net debt is less, at about CN¥19.2b.
How Healthy Is Panda Green Energy Group’s Balance Sheet?
We can see from the most recent balance sheet that Panda Green Energy Group had liabilities of CN¥8.20b falling due within a year, and liabilities of CN¥14.2b due beyond that. Offsetting these obligations, it had cash of CN¥394.0m as well as receivables valued at CN¥5.20b due within 12 months. So it has liabilities totalling CN¥16.8b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CN¥3.29b 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, Panda Green Energy Group 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 1.0 times and a disturbingly high net debt to EBITDA ratio of 10.0 hit our confidence in Panda Green Energy Group like a one-two punch to the gut. This means we’d consider it to have a heavy debt load. Looking on the bright side, Panda Green Energy Group boosted its EBIT by a silky 58% in the last year. Like a mother’s loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Panda Green Energy Group’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
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. During the last three years, Panda Green Energy Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
On the face of it, Panda Green Energy Group’s conversion of EBIT to free cash flow 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. But at least it’s pretty decent at growing its EBIT; that’s encouraging. After considering the datapoints discussed, we think Panda Green Energy 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. However, not all investment risk resides within the balance sheet – far from it. Like risks, for instance. Every company has them, and we’ve spotted 4 warning signs for Panda Green Energy Group (of which 1 shouldn’t be ignored!) you should know about.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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