These 4 Measures Indicate That Zheneng Jinjiang Environment Holding (SGX:BWM) Is Using Debt In A Risky Way

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Zheneng Jinjiang Environment Holding Company Limited (SGX:BWM) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zheneng Jinjiang Environment Holding

How Much Debt Does Zheneng Jinjiang Environment Holding Carry?

As you can see below, at the end of December 2020, Zheneng Jinjiang Environment Holding had CN¥8.68b of debt, up from CN¥7.47b a year ago. Click the image for more detail. However, it does have CN¥361.3m in cash offsetting this, leading to net debt of about CN¥8.32b.

How Healthy Is Zheneng Jinjiang Environment Holding's Balance Sheet?

The latest balance sheet data shows that Zheneng Jinjiang Environment Holding had liabilities of CN¥4.84b due within a year, and liabilities of CN¥7.01b falling due after that. On the other hand, it had cash of CN¥361.3m and CN¥3.04b worth of receivables due within a year. So its liabilities total CN¥8.44b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥4.30b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Zheneng Jinjiang Environment Holding would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Weak interest cover of 1.9 times and a disturbingly high net debt to EBITDA ratio of 7.0 hit our confidence in Zheneng Jinjiang Environment Holding like a one-two punch to the gut. The debt burden here is substantial. Even more troubling is the fact that Zheneng Jinjiang Environment Holding actually let its EBIT decrease by 5.0% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zheneng Jinjiang Environment Holding 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 we always check how much of that EBIT is translated into free cash flow. Over the last three years, Zheneng Jinjiang Environment Holding 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

On the face of it, Zheneng Jinjiang Environment Holding'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. And furthermore, its interest cover also fails to instill confidence. We think the chances that Zheneng Jinjiang Environment Holding has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zheneng Jinjiang Environment Holding has 2 warning signs we think you should be aware of.

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.

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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. 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.
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