Is Datang International Power Generation (HKG:991) A Risky Investment?

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.' 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. Importantly, Datang International Power Generation Co., Ltd. (HKG:991) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Datang International Power Generation

How Much Debt Does Datang International Power Generation Carry?

As you can see below, Datang International Power Generation had CN¥172.5b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥9.26b in cash offsetting this, leading to net debt of about CN¥163.2b.

A Look At Datang International Power Generation's Liabilities

We can see from the most recent balance sheet that Datang International Power Generation had liabilities of CN¥84.9b falling due within a year, and liabilities of CN¥131.5b due beyond that. On the other hand, it had cash of CN¥9.26b and CN¥21.6b worth of receivables due within a year. So its liabilities total CN¥185.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥50.1b 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'd watch its balance sheet closely, without a doubt. At the end of the day, Datang International Power Generation 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.

Datang International Power Generation shareholders face the double whammy of a high net debt to EBITDA ratio (10.1), and fairly weak interest coverage, since EBIT is just 1.0 times the interest expense. The debt burden here is substantial. One redeeming factor for Datang International Power Generation is that it turned last year's EBIT loss into a gain of CN¥3.0b, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Datang International Power Generation'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.

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. Over the last year, Datang International Power Generation saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Datang International Power Generation's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We think the chances that Datang International Power Generation has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. 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. We've identified 2 warning signs with Datang International Power Generation (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.