Datang International Power Generation (HKG:991) Has A Somewhat Strained Balance Sheet

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. We note that Datang International Power Generation Co., Ltd. (HKG:991) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Datang International Power Generation

What Is Datang International Power Generation's Debt?

As you can see below, Datang International Power Generation had CN¥171.8b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥10.9b, its net debt is less, at about CN¥160.9b.

How Healthy Is Datang International Power Generation's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Datang International Power Generation had liabilities of CN¥88.6b due within 12 months and liabilities of CN¥124.0b due beyond that. On the other hand, it had cash of CN¥10.9b and CN¥21.4b worth of receivables due within a year. So it has liabilities totalling CN¥180.3b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥45.9b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Datang International Power Generation would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Datang International Power Generation has a rather high debt to EBITDA ratio of 6.4 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.7 times, suggesting it can responsibly service its obligations. However, it should be some comfort for shareholders to recall that Datang International Power Generation actually grew its EBIT by a hefty 282%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Datang International Power Generation will need earnings to service that debt. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last two years, Datang International Power Generation 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

To be frank both Datang International Power Generation's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Datang International Power Generation to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 be aware of the 2 warning signs we've spotted with Datang International Power Generation .

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.