Health Check: How Prudently Does Datang International Power Generation (HKG:991) Use Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Datang International Power Generation Co., Ltd. (HKG:991) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Datang International Power Generation

What Is Datang International Power Generation's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Datang International Power Generation had CN¥172.7b of debt, an increase on CN¥149.8b, over one year. On the flip side, it has CN¥10.6b in cash leading to net debt of about CN¥162.1b.

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

The latest balance sheet data shows that Datang International Power Generation had liabilities of CN¥94.9b due within a year, and liabilities of CN¥120.7b falling due after that. Offsetting these obligations, it had cash of CN¥10.6b as well as receivables valued at CN¥22.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥182.6b.

The deficiency here weighs heavily on the CN¥42.1b 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 definitely think shareholders need to watch this one closely. After all, Datang International Power Generation would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Datang International Power Generation'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.

In the last year Datang International Power Generation wasn't profitable at an EBIT level, but managed to grow its revenue by 9.4%, to CN¥108b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Datang International Power Generation had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥6.7b. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through CN¥5.8b in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. To that end, you should be aware of the 2 warning signs we've spotted with Datang International Power Generation .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.